HL Economics

Chapter 12: Aggregate Demand/Supply


4) Identify the components of aggregate demand and briefly explain two factors which might determine each of theese components

Aggregate demand can be defined as the total demand for a nation’s goods and services demanded from the domestic households, firms, government and foreigners. Thus we can formulate an equation of factors which effect the aggregate demand: C + I + G + (X-M). C stands for consumption, which is the measure of all spendings on goods and services by the households, during a certain period of time. Wealth effects the households consumption of goods as the more wealthier they feel, the more they will consume. E.g. If the taxes decrease, this will cause households to have more money to spend and thus may demand more goods/services. Interest rates are also another factor of consumption, in which when there is an increase in interest rate, consumption will fall whereas when it decreases consumption will increase. When the interest rate increases, many households tend to save their money because of the larger gain they may receive than spending. I is for investment or gross domestic private investment, which measures the total spending by firms on the capital equipment. Interest rate also falls into this component as well. Also, firms may increase in investment if the households demand more of the products of the firm. G is for government spending, and measures the country’s government expenditures on goods and services. In this factor, more subsidies for the households for schools, health care, etc. will allow them to have more money to spend on goods and services, thus increasing demand. Lastly, (X-M) stands for Exports and Imports or the net exports, which measures the total income earned from the sales of exports minus the total spending by nation’s households/firms/government on goods/services imported from other nations. When the power of the nation’s currency increases, the price of goods increase and thus results to a decrease in exports. This specific example is present in Japan currently.


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