Aggregate demand and aggregate supply model

5.Some examples of questions that can be answered using that model
Investments of fixed capital (such as machinery, plants, or factories) and social capital (such as roads and socially owned hospitals).
Inventory investments in stocks of raw materials such as iron, metal, lithium or other components necessary for production, semi-finished goods such as glass, gold or silver, and finished goods, electronics, food, etc.
Other factors firms need to take into account when making investment decisions are:
Price of labour.
Price of capital (the cost of producing the capital as well as the cost of using the capital for the firm).
Technological development.
Expected future sales revenue attributed to the new machinery.
Expected costs of production from the machinery and interest payments made from the borrowing to fund the machinery in the first place.
Maintenance costs of the machinery.
Expected future profit to be yielded from the machinery.
Government spending in aggregate demand
Government spending is a key component of aggregate demand. The decisions of a government on where to spend the money can have a big regional impact to promote economic activity. It is also important that the government spends more money on the public to provide merit as well as public goods.
Government spending is the spending of the public sector of the economy on goods and services.
There are three forms of government spending:
Welfare spending. Otherwise known as transfer payments. As an example, we can look at the welfare offered by the UK: social welfare services such as job seeker allowances, universal credit welfare rates, etc.
Recurring spending. Otherwise known as public services such as police, fire brigade, state education, national health services, local authority services.
State investments. Otherwise known as capital investments, this is spending on capital goods needed to provide public services such as infrastructure, public buildings, etc.
Other main examples of government spending include the field of education where the state invests in building schools or public infrastructures such as roads, health care (hospitals), and defence (military).
Net exports in aggregate demand
Before looking at the concept of net exports let’s quickly revisit the definition of exports and imports.
Exporting is the act of selling goods and services to another country, whereas importing is the act of receiving goods and services from another country.
The net exports of a country, otherwise known as net trade balance, is the difference between the value of exports minus imports (X - M). If the value of the exports of a country is greater than the value of imports, the trade balance is in surplus. When the value of the imports of a country is greater than the value of exports, the trade balance of that country is in deficit.
The income generated from these exports from the perspective of the exporting country is seen as an injection into the circular flow of income and adds to the aggregate demand (AD).
Factors influencing the trade balance
Relative prices of goods and services in the world markets. For example, the prices of certain goods and services may vary between the UK and Germany or between the UK and China. Chinese goods and services will be cheaper, for example, due to the fact that the cost of production of these goods and services is vastly cheaper. Their quality is also lower than that of goods produced in Germany.
The exchange rate. Usually, a stronger currency makes exports more expensive as to buy the goods and services, a nation first has to acquire the necessary currency whose price is costlier in relation to the nation’s own currency. For example, if the Sterling pound were to appreciate and increase in value against the Euro, it would mean that European countries would have to first buy the costlier British pounds to import goods and services from the UK. In addition, from the UK’s point of view, imports from the European Union would become cheaper as the value of the British pound would have appreciated in comparison to the Euro.
Strength of aggregate demand in key export markets. If the UK exports 10% of its goods and services to the US due to strong trade ties, and the US, for example, enters a recession due to lower AD, it would be difficult for the UK to find new key export markets as aggregate demand for UK goods and services in the US would be low and UK exports towards the US would decrease.
Non-price demand factors, for example how effective and good are the designs, innovations, branding and performance of the goods and services that are being exported.
Aggregate demand and the level of economic activity
Economic activity is the process of production and consumption of goods and services in an economy at a particular time. It takes into account the employment of labour, capital, and other inputs that produce output.
In this context, economic activity will also hold a relation to the employment levels in an economy as we are trying to realise the relationship between the aggregate demand and real output. When the real output increases, businesses have to hire more labour/workers in order to produce more goods and services, and that process alone involves a large labour supply. Conversely, when real output decreases, firms tend to demand less labour as there is little demand to produce these goods and services
Aggregate Demand - Key takeaways
Aggregate demand is a measure of total expenditure on a country’s goods and services. It measures the total amount of spending in an economy.
The four components of aggregate demand are consumption, investments, government spending, and net exports.
Consumption refers to the total amount of planned spending by households on goods and services that are produced in the economy.
Investment can be referred to as spending on capital goods such as factories, plants and machinery, buildings, new technology, and vehicles.
Government spending is spending by the public sector of the economy on goods and services such as education, public infrastructure, health care, and defence.
The net exports of a country, otherwise known as net trade balance, is the difference between the value of exports and imports.
Economic activity is the process of production and consumption of goods and services in an economy at a particular time. It takes into account the employment of labour, capital, and other inputs that produce output.
Frequently Asked Questions about Aggregate Demand
What is aggregate demand?
CONCLUSION
Aggregate demand (AD) is the total planned spending on the goods and services produced in the economy in a particular period. Aggregate demand measures how much are consumers, businesses, the government, and people and firms overseas spending on goods and services. What are examples of aggregate demand When referring to examples of aggregate demand we mainly refer to goods and services households spend their money on, capital goods such as machinery that firms invest in, and infrastructure projects that government invests in to promote economic activity.If there is an increase in the components of aggregate demand such as higher consumption levels, more investments of firms in projects, more government spending on infrastructure, or increased exports in trade, there will be increased economic growth. Conversely, a decrease in these components will lead to a decrease in aggregate demand and hence a fall in economic growth.Final Aggregate Demand Quiz

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