Components of Aggregate Demand

Question 1

What are the four components (non-price determinants) of aggregate demand?

Answer 1

1. Demand of consumers (C)
2. Demand of businesses (I)
3. Demand of government (G)
4. Net exports (X-M)

Question 2

How do the four components affect aggregate demand curve?

Answer 2

1. An increase in any of the four components of aggregate demand will cause the curve to shift rightwards
2. A decrease in any of the four components of aggregate demand will cause the curve to shift leftwards

Question 3

What are the 5 causes of changes in consumer spending (C)?

Answer 3

1. Changes in taxes
   - increase in taxes => decrease in disposable income => decrease in C
   - decrease in taxes => increase in disposable income => increase in C
2. Consumer Confidence (Expectations)
   - if income is expected to increase, spending will increase
   - if pessimistic about future, spending will decrease (savings increase)
3. Changes in interest rates
   - increased interest rates => decrease in borrowing => decrease in spending
   - decreased interest rates => increase in borrowing => increase in spending
4. Changes in wealth
   - wealth: value of assets owned
   - increased wealth => increased feeling of affluence => increase spending
   - decreased wealth => decreased feeling of affluence => decreased spending
5. Changes in level of household debt
   - high level of debt => decrease in spending
   - low level of debt => increase in spending

Question 4

What are the 7 causes of changes in investment spending (I)?

Answer 4

1. Changes in interest rates
   - increases in interest rates => reduced I (borrowing)
   - decreases in interest rates => increased I
2. Changes in business confidence about future
3. Improvements in technology
   - makes firms more efficient => reduced costs => increased spending
4. Changes in business taxes
5. The degree of excess capacity
   - if producing below their maximum level, less likely to invest since output can be increased without extra costs of production
6. Level of corporate indebtedness
7. Changes in laws
   - increased access to credit or securing property rights

Question 5

What are the 3 causes of changes in government spending?

Answer 5

1. Political priorities
2. Economic priorities (expansionary fiscal policy or contractionary fiscal policy)
3. Budget surplus/deficit

Question 6

What are the 4 causes of changes in net export?

Answer 6

1. Changes in national income abroad
   - if country B’s national income increases, it will import more from country A
   - if country B’s national income decreases, it will import less from country A
2. Changes in exchange rates
   - if exchange rates increase, exports to other countries will become expensive while imports from other countries become cheaper (decrease in X - M)
   - vice versa
3. Changes in the level of trade protection
   - more restrictions on imports in other countries => reduction in exports
4. Tastes and preferences