Aggregate demand and its determinants
Definition of Aggregate Demand
Aggregate demand refers to the "sum total of all the goods and services demanded by all the people including government in a year." It includes consumption demand (C), investment demand (I), Government demand (g) , foreign demand (x-m)
In short,
AD=C+I+G+(X-M)
COMPONENTS OF OR DETERMINANTS OF AGGREGATE DEMAND
1)consumption demand/consumption expenditure (c):
Consumption demand refers to the demand for consumer goods. Consumer goods refer to those goods which satisfy the person's want directly.
E.g.: Food grains ,vegetables, fruits, t.v., washing machine, etc.
The demand for consumer goods depends upon-
A) Income(y)
B) propensity to consume (c)
If the income is high, the demand for consumers goods is also high and vice-versa. In short there is a direct relationship between income and consumption demand.
Consumption demand also depends upon propensity to consume. Propensity to consume means desire or willingness to consume. Higher the propensity to consume higher is the consumption demand and vice-versa. In short there is direct relationship between propensity to consume and consumption demand.
2) Investment demand (I)
Investment demand refers to the demand for capital goods or investment goods.
E.g.: Raw material, machinery, factory, etc.
The demand for investment goods depends upon-
A) Rate of interest
B) Marginal efficiency of capital
A)Rate of interest
If the rate of interest is high the producers will borrow less loan and invest in raw material, factory etc. It means higher the rate of interest lower the investment and vice - versa. In short, there is an inverse relationship between rate of interest and investment demand.
B) Marginal efficiency of capital
Investment demand also depends upon marginal efficiency of capital (MEC). MEC refers to the expected/anticipated rate of profit from investment. If the rate of profit is expected to be high or if MEC is high then investment demand also more and vice-versa. In short, there is a direct relationship between MEC and investment demand.
3) Government Demand (G)
Government demand refers to the goods and services demanded by the government in order to perform various functions as follows:
1. To maintain law and order.
2. To maintain defence, police, justice, etc.
3. Establishment of economic overheads like roads, railways, canals, dams, etc.
4. Establishment of social overhead like schools, colleges, public gardens, public hospitals, etc.
5. To maintain Govt. Offices, Govt. Quarters, etc.
6.To maintain public administration, etc.
There are two types of govt. Demand/investment:
1. Autonomous expenditure/investment refers to those expenditure which are not depending upon income or rate of interest.
2. Induced consumption /investment refers to those expenditure which depends upon the rate of interest or income. Most of the government expenditure / investment are autonomous investments. The rate of interest may be low or high; the govt. expenditure in defence, police, justice etc. Will be done automatically.
4) Foreign demand (X-M):
The excess of exports (x) over imports (m) is known as foreign demand. Every country is keeping the records of the value of exports and imports . The systematic record of the value of exports and imports is called balance of payment (BOP). There are 3 types of BOP's
1) favourable BOP
2) Unfavourable BOP
3) Equilibrium BOP
If the value of export is greater then the value of import then, it is called favourable BOP.
If the value of export is less then Import then, it is called unfavorable BOP.
If the value of export is equal to import then, it is called Equilibrium BOP.
As, income keeps on rising, aggregate demand also keeps on rising. Due to this direct relationship between income and aggregate demand, the aggregate demand curve slopes upwards from left to right as shown in the following diagram.
Aggregate demand refers to the "sum total of all the goods and services demanded by all the people including government in a year." It includes consumption demand (C), investment demand (I), Government demand (g) , foreign demand (x-m)
In short,
AD=C+I+G+(X-M)
COMPONENTS OF OR DETERMINANTS OF AGGREGATE DEMAND
1)consumption demand/consumption expenditure (c):
Consumption demand refers to the demand for consumer goods. Consumer goods refer to those goods which satisfy the person's want directly.
E.g.: Food grains ,vegetables, fruits, t.v., washing machine, etc.
The demand for consumer goods depends upon-
A) Income(y)
B) propensity to consume (c)
If the income is high, the demand for consumers goods is also high and vice-versa. In short there is a direct relationship between income and consumption demand.
Consumption demand also depends upon propensity to consume. Propensity to consume means desire or willingness to consume. Higher the propensity to consume higher is the consumption demand and vice-versa. In short there is direct relationship between propensity to consume and consumption demand.
2) Investment demand (I)
Investment demand refers to the demand for capital goods or investment goods.
E.g.: Raw material, machinery, factory, etc.
The demand for investment goods depends upon-
A) Rate of interest
B) Marginal efficiency of capital
A)Rate of interest
If the rate of interest is high the producers will borrow less loan and invest in raw material, factory etc. It means higher the rate of interest lower the investment and vice - versa. In short, there is an inverse relationship between rate of interest and investment demand.
B) Marginal efficiency of capital
Investment demand also depends upon marginal efficiency of capital (MEC). MEC refers to the expected/anticipated rate of profit from investment. If the rate of profit is expected to be high or if MEC is high then investment demand also more and vice-versa. In short, there is a direct relationship between MEC and investment demand.
3) Government Demand (G)
Government demand refers to the goods and services demanded by the government in order to perform various functions as follows:
1. To maintain law and order.
2. To maintain defence, police, justice, etc.
3. Establishment of economic overheads like roads, railways, canals, dams, etc.
4. Establishment of social overhead like schools, colleges, public gardens, public hospitals, etc.
5. To maintain Govt. Offices, Govt. Quarters, etc.
6.To maintain public administration, etc.
There are two types of govt. Demand/investment:
1. Autonomous expenditure/investment refers to those expenditure which are not depending upon income or rate of interest.
2. Induced consumption /investment refers to those expenditure which depends upon the rate of interest or income. Most of the government expenditure / investment are autonomous investments. The rate of interest may be low or high; the govt. expenditure in defence, police, justice etc. Will be done automatically.
4) Foreign demand (X-M):
The excess of exports (x) over imports (m) is known as foreign demand. Every country is keeping the records of the value of exports and imports . The systematic record of the value of exports and imports is called balance of payment (BOP). There are 3 types of BOP's
1) favourable BOP
2) Unfavourable BOP
3) Equilibrium BOP
If the value of export is greater then the value of import then, it is called favourable BOP.
If the value of export is less then Import then, it is called unfavorable BOP.
If the value of export is equal to import then, it is called Equilibrium BOP.
As, income keeps on rising, aggregate demand also keeps on rising. Due to this direct relationship between income and aggregate demand, the aggregate demand curve slopes upwards from left to right as shown in the following diagram.
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| Diagram |
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