Determinants of Aggregate

Demand
By Samran and the Fudu.
 What is AD?
• AD is the total planned spending on real
output produced with in the economy.
 Formula of AD:
AD = C + I + G + ( X – M )
C = CONSUMPTION
I = INVESTMENTS
G= GOVERNMENT SPENDING
X= EXPORTS
M= IMPORTS
( X – M ) = NET EXPORT DEMAND
 Definitions
• Consumption - total planned spending by households
on real output produced with in the economy.

• Investment - total planned spending by firms on real

output produced within the economy. For example
spending by firms on capital goods such as machines
and raw materials.

• Saving - income which is not spent on consumption.

 Determinants of Consumption:
• Interest rates: reward for lending savings to somebody else.

• Consumer confidence: when consumer optimism increases

households generally spend more and save less and vice versa.

• Wealth: is the stock of assets, or things that have value which

people own.

• Availability of credit: the rate of interest, controls bank lending

and higher purchase controls affects consumption. If credit is
cheap and is easily available, consumption increases.
 Determinants of Consumption:
• Distribution of income: rich people save a greater proportion of
income then the poor.

• Future inflation: Uncertainty is caused by fears of rising inflation

reducing consumption. However, this may have the opposite effect
that households may consume more now if the prices continue to
rise.

• Level of Income: As income increases there is an increase in

consumption but not as much.

• Life Cycle Theory of Consumption.

 Determinants of Investment:
• Replacement Investment: Maintaining the size of existing capital
stock by replacing worn-out capital.

• Net Investment: Adds to the capital stock therefore increasing the

productive potential.

• Investment in fixed capital: New factories and social capital such as

roads.

• Inventory Investment: Stocks of raw materials or variable capital.

• Accelerator Theory of Investment.

The End.