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2.3 What is aggregate demand (AD)?



What students need to learn:

Content
Students should be able to:
Additional Guidance Notes
The components of AD:
C + I + G + (X — M)
Understand the factors influencing the components of AD.
Students should understand the relative importance of these components, for example consumption comprises approximately 65 per cent of AD.
Consumption (C)
Understand the main influences on consumer spending, for example: interest rates; consumer confidence; wealth effects. Understand how changes in house prices may affect consumer spending.
Recognition of the importance of consumption as a component of AD should be used as an evaluative tool.
Investment (I)
Understand the main influences on investment, for example: interest rates; confidence levels; risk; the influence of government and regulations.
The accelerator effect and Marginal Efficiency of Capital theory are not required.
Government
expenditure (G)
Understand the main influences on government spending, for example the deliberate manipulation of the economy through fiscal policy.
Students should understand that the budget does not have to balance in the short run, and be able to assess the impact of an imbalance on the flow of income.
Exports — Imports (X-M)
Understand the impact on the current account of factors including:
  • a change in the exchange rate
  • changes in the state of the world economy
  • non-price factors.

Evaluation of these influences is required, for example:
  • the change in the exchange rate might have opposite effects in the short and long run
  • a stronger currency makes exports relatively uncompetitive and imports relatively cheap. This decreases AD as value of X falls and value of M rises.

However:
  • the price elasticity of demand for exports and imports may be very low meaning the stronger currency worsens the current account in the short run.

Students are not expected to have knowledge of the Marshall-Lerner condition or J-curve analysis.
Movements along and shifts of the AD curve
Understand why AD slopes downwards.

Show the relevant shifts in the AD curve when one of the components change.
Students should distinguish between levels of the components and the changes in components. For example, falls in the rate of investment may mean that AD rises more slowly.

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