3.2.1

Aggregate Demand

Test yourself on Aggregate Demand

Test your knowledge with free interactive questions on Seneca — used by over 10 million students.

Aggregate Demand (AD)

AD is equal to the sum of net exports, consumption, investment and government spending at a given price level.

Aggregate Demand

Aggregate Demand

  • Aggregate Demand (AD) = Consumption (C) + Investment (I) + Government Spending (G) + Net Trade/Exports-Imports (X-M).
  • Arguably, consumption is the most important component of the aggregate demand curve.
Aggregate demand curve

Aggregate demand curve

  • The AD curve is downward sloping.
  • Consumption will fall as the price level rises - a movement (not a shift) along the AD curve.

Shifts and Movements in the Aggregate Demand Curve

As well as movements along, the AD and AS curves can shift because of changes in the demand or supply side of the economy.

Shifts in AD

Shifts in AD

  • AD shifts because of a change in any of consumption, investment, government spending, exports or imports. This can be caused by changes in behaviour or changes in government policy.
    • E.g changes in business confidence or taxation. If firms are more confident, they are more likely to borrow to finance investment. This shifts AD right and AD is now higher at every price level.
Demand 'shocks'

Demand 'shocks'

  • A demand-side shock is anything (positive or negative) that causes AD to change.
  • Examples of a negative shock could be an interest rate rise, a collapse in the housing market, etc.
  • As well as a fall in real GDP, this could have a knock-on effect on confidence, leading to further falls in activity.
  • The multiplier and accelerator effects could magnify the impact of any initial negative shock.
  • Keynesians may suggest government intervention would be required at this point.

Movements along the AD curve

  • Movements along the AD curve are caused by a change in the average price level (the two have an inverse relationship).
    • E.g. a rise in the average price level leads to a contraction of AD.
  • The average price level can lead to several things:
    • Real incomes: A rise in the average price level can lead to the real value of income to drop.
    • Balance of trade: If the average price level of a foreign country fell, domestic consumers would demand more imports, causing a contraction in AD.
    • Interest rates: If the average price level rises, there will be inflation.

Aggregate Demand (AD) - Consumption and Investment

Aggregate Demand (AD) is defined as the total value of planned expenditure on goods and services produced in an economy in a given period of time.

Components of AD

Components of AD

  • The formula for AD is AD = C + I + G + (X-M).
    • C is Consumption.
    • I is Investment.
    • G is Government Spending.
    • X is Exports.
    • M is Imports.
Consumption

Consumption

  • A number of factors affect the level of consumption (C):
    • Wealth levels.
    • Income levels.
    • Future expectations of inflation.
    • Animal spirits (confidence).
    • Unemployment levels.
    • Job security.
Types of investment

Types of investment

  • Investment is defined as expenditure that increases the capital stock of a country.
  • Investment in physical capital would be expenditure by firms on plant and machinery.
  • Investment in human capital is expenditure by firms on the skills of its workers e.g. training programmes.
Factors affecting investment

Factors affecting investment

  • A number of factors affect the level of investment:
    • Interest rates.
    • Future growth and demand.
    • Profitability.
    • Government policies e.g. corporate tax, subsidies.
    • Efficiency of financial system.
Types of government spending

Types of government spending

  • Government spending could be on current spending or capital spending:
    • Current spending is on transfer payments such as benefits, or on the day to day running of government e.g. salaries, utility bills.
    • Capital spending is on long-term spending that increases the productive capacity of the economy e.g infrastructure projects.
Government spending

Government spending

  • A number of factors affect the level of government spending:
    • Cost of borrowing.
    • Fiscal deficit or debt targets.
    • Levels of national debt.
    • State of the economy.
    • Confidence in the economy.
    • Political bias.
Exports and imports

Exports and imports

  • A number of factors affect the level of exports and imports:
    • The exchange rate determines relative prices of exports and imports.
    • The quality of goods affects international competitiveness.
    • Relative inflation rates affect domestic vs international prices.
    • Relative levels of income. The higher the domestic income, the higher the marginal propensity to import.
    • How much spare capacity there is to supply resources. The less there is, the more raw materials will need to be imported.
Jump to other topics
1

Introduction to Markets

1.1

Nature of Economics

1.1.1Economics as a Social Science1.1.2Positive & Normative Economic Statements1.1.3The Economic Problem1.1.4Resources1.1.5Production Possibility Frontiers1.1.6Specialisation & Division of Labour1.1.7Types of Economies1.1.8End of Topic Test - Nature of Economics1.1.9Application Questions - Nature of Economics
1.2

How Markets Work

1.2.1Rational Decision Making1.2.2Demand1.2.3Elasticities of Demand1.2.4Elasticities of Demand 21.2.5Elasticity & Revenue1.2.6Supply1.2.7Elasticity of Supply1.2.8Price Determination1.2.9Price Mechanism1.2.10Consumer & Producer Surplus1.2.11Indirect Taxes & Subsidies1.2.12A-A* (AO3/4) - Taxing Prices or Quantities?1.2.13Alternative View of Consumer Behaviour1.2.14End of Topic Test - Markets1.2.15A-A* (AO3/4) - Markets
2

Market Failure

2.1

Market Failure

2.1.1Types of Market Failure2.1.2Externalities2.1.3The Deadweight Welfare Loss of Externalities2.1.4A-A* (AO3/4) - The Externalities of Education2.1.5Public Goods2.1.6Information Gaps2.1.7End of Topic Test - Market Failure2.1.8Application Questions - Market Failure
2.2

Government Intervention

2.2.1Government Intervention in Markets2.2.2Subsidies & Price Controls2.2.3Pollution Permits & Regulation2.2.4A-A* (AO3/4) - European Emissions Trading2.2.5State Provision & Information Provision2.2.6Government Failure2.2.7End of Topic Test - Government Intervention2.2.8A-A* (AO3/4) - Government Intervention
3

The UK Macroeconomy

3.1

Measures of Economic Performance

3.1.1Measuring Economic Growth3.1.2National Income Data3.1.3Inflation3.1.4Causes of Inflation3.1.5Consequences of Inflation3.1.6Employment & Unemployment3.1.7Causes & Impact of Unemployment3.1.8A-A* (AO3/4) - Hysteresis3.1.9Balance of Payments3.1.10Current Account Deficit & Imbalances3.1.11End of Topic Test - Economic Performance3.1.12Application Questions Macroeconomy
3.2

Aggregate Demand

3.2.1Aggregate Demand3.2.2Consumption3.2.3Investment3.2.4Government Expenditure3.2.5Net Trade3.2.6End of Topic Test - Aggregated Demand3.2.7Application Questions - AD
3.3

Aggregate Supply

3.3.1Aggregate Supply3.3.2End of Topic Test - Aggregated Supply3.3.3A-A* (AO3/4) -Aggregate Supply
3.4

National Income

3.4.1National Income3.4.2Injections & Withdrawals3.4.3Equilibrium Level of Real National Output3.4.4Multiplier Effect3.4.5End of Topic Test - National Income3.4.6Application Questions - National Income
3.5

Economic Growth

3.5.1Causes of Economic Growth3.5.2Output Gaps3.5.3Business Cycle3.5.4Impact of Economic Growth3.5.5End of Topic Test - Economic Growth3.5.6A-A* (AO3/4) - Growth
4

The UK Economy - Policies

4.1

Macroeconomic Objectives & Policies

4.1.1Possible Objectives4.1.2Demand-Side Policies - Monetary4.1.3Demand-Side Policies - Monetary 24.1.4A-A* (AO3/4) - The Future of Interest Rates4.1.5Demand-Side Policies - Fiscal4.1.6Demand-Side Policies in 2007-084.1.7Strengths & Weaknesses of Demand Side4.1.8Supply-Side Policies4.1.9Supply-Side Policies 24.1.10Conflicts Between Objectives4.1.11A-A* (AO3/4) - Conflicting Incentives4.1.12Phillips Curve4.1.13End of Topic Topic - Policies & Objectives4.1.14Application Questions - UK Policies
5

Business Behaviour

5.1

Business Growth

5.1.1Size & Types of Firms5.1.2Business Growth5.1.3Pros & Cons of External Expansion5.1.4Demergers5.1.5End of Topic Test - Business Growth5.1.6A-A* (AO3/4) - Business Growth
5.2

Business Objectives

5.2.1Business Objectives5.2.2End of Topic Test - Business Objectives5.2.3Application Questions - Business Objectives
5.3

Revenues, Costs & Profits

5.3.1Revenue5.3.2Costs5.3.3Economies & Diseconomies of Scale5.3.4Profits5.3.5Profits 25.3.6End of Topic Test - Revenue, Costs & Profits5.3.7A-A* (AO3/4) - Revenue, Costs & Profit
6

Market Structures

6.1

Market Structures

6.1.1Efficiency6.1.2Perfect Competition6.1.3Perfect Competition 26.1.4Monopolistic Competition6.1.5Oligopolies6.1.6The Prisoner's Dilemma6.1.7Collusion in Oligopolistic Markets6.1.8A-A* (AO3/4) - Which Factors Affect Collusion?6.1.9Monopolies6.1.10Price Discrimination6.1.11Monopsony6.1.12A-A* (AO3/4) - Models in Economics6.1.13Contestability6.1.14Benefits of Contestability6.1.15End of Topic Test - Market Structures6.1.16Application Questions - Market Structures6.1.17A-A* (AO3/4) - Cereal Collusion
6.2

Labour Market

6.2.1Demand for Labour6.2.2Supply of Labour6.2.3Labour Market Imperfections6.2.4A-A* (AO3/4) - Labour Productivity & Unemployment6.2.5A-A* (AO3/4) - What Level of Unionisation is Good?6.2.6Wage Determination6.2.7Elasticity of Labour Supply & Demand6.2.8Intervention in Setting Wages6.2.9End of Topic Test - Labour Market6.2.10A-A* (AO3/4) - Labour Markets
6.3

Government Intervention

6.3.1Reasons for Government Intervention6.3.2Government Promotion of Competition6.3.3Usefulness of Competition Policy & Examples6.3.4A-A* (AO3/4) - Modern Competition Policy6.3.5Privatisation6.3.6Government Regulation6.3.7A-A* (AO3/4) - Nationalisation vs Privatisation6.3.8Government Protection of Suppliers and Employees6.3.9Impact of Government Intervention6.3.10End of Topic Test - Government Intervention6.3.11Application Questions - Government Intervention
7

A Global Perspective

7.1

International Economics - Globalisation & Trade

7.1.1Globalisation7.1.2Globalisation for LEDCs7.1.3Globalisation for MEDCs7.1.4Specialisation & Trade7.1.5Pattern of Trade7.1.6Terms of Trade7.1.7Trading Blocs7.1.8UK, EU & WTO7.1.9End of Topic Test - Globalisation & Trade7.1.10A-A* (AO3/4) - Globalisation & Trade
7.2

International Economics - Currency

7.2.1Merged Currency7.2.2Restrictions on Free Trade7.2.3Arguments for Protectionism7.2.4Arguments Against Protectionism7.2.5Balance of Payments7.2.6Balance of Payments 27.2.7Floating Exchange Rates7.2.8Fixed Exchange Rate7.2.9International Competitiveness7.2.10End of Topic Test - International Economy7.2.11Application Questions - International Economics
8

Finance & Inequality

8.1

Poverty & Inequality

8.1.1Absolute & Relative Poverty8.1.2Inequality8.1.3Inequality 28.1.4Lorenz Curve8.1.5Government Policy on Poverty8.1.6End of Topic Test - Poverty & Inequality8.1.7A-A* (AO3/4) - Inequality & Poverty
8.2

Emerging & Developing Economies

8.2.1Measures of Development8.2.2Factors Influencing Growth & Development8.2.3Barriers to Development8.2.4Barriers to Development 28.2.5A-A* (AO3/4) - The Bottom Billion8.2.6Development Strategies8.2.7Interventionist Strategies8.2.8Aid8.2.9International Institutions8.2.10International Institutions 28.2.11End of Topic Test - Emerging & Developing8.2.12Application Questions - Developing Countries
8.3

The Financial Sector

8.3.1Role of Financial Markets8.3.2Market Failure in the Financial Sector8.3.3Role of Central Banks8.3.4End of Topic Test - The Financial Sector8.3.5A-A* (AO3/4) - Financial Sector
8.4

Role of the State in the Macroeconomy

8.4.1Public Expenditure8.4.2Taxation8.4.3Public Sector Finances8.4.4End of Topic Test - Role of the State8.4.5Application Questions - Role of the State
9

Examples of Global Policy

9.1

International Policies

9.1.1Global Debt & Deficit Policies9.1.2Poverty & Inequality Policies9.1.3Changes in Interest Rates9.1.4Competitiveness Policies9.1.5End of Topic Test - International Policies9.1.6A-A* (AO3/4) - International Policies
9.2

Policy Responses to Shocks

9.2.1International Tax Policies9.2.2Problems for Policymakers9.2.3End of Topic Test - Policy Responses9.2.4Application Questions - Policy Responses

Practice questions on Aggregate Demand

Can you answer these? Test yourself with free interactive practice on Seneca — used by over 10 million students.

  1. 1
    What is the shape of the AD curve?Multiple choice
  2. 2
    Which component is arguably the most important component of AD?Multiple choice
  3. 3
    What is on the vertical axis of a AD graph?Multiple choice
  4. 4
    Which of the following would lead to an increase in aggregate demand?Multiple choice
  5. 5
    Impact of a Demand ShockPut in order
Answer all questions on Aggregate Demand

Unlock your full potential with Seneca Premium

  • Unlimited access to 10,000+ open-ended exam questions

  • Mini-mock exams based on your study history

  • Unlock 800+ premium courses & e-books

Get started with Seneca Premium

Application Questions Macroeconomy

Consumption