Aggregate Demand

Determinants of AD Components (AO2)

You shouldn't need to memorize all of these, because most of them just make sense. Underlined determinants are the biggest factors in of the component (you don't need to know that, but it is a plus for evaluation).

• Consumption: 

  • • Consumer confidence in the economy: Low in recessions, high in booms. Higher confidence, more consumption (and vice versa).

    • Interest rates: Interest rates affect the cost of borrowing money. Higher rates, less consumption (and vice versa).

    • Wealth: More disposable income, more consumption (and vice versa).

    • Income Taxes: More taxes, less disposable income, less consumption (and vice versa). 

    • Level of household debt: More debt, less money to spend, less consumption (and vice versa).

    • Expectations of future price levels: If things are going to be more expensive in the future, people spend now (and vice versa). 

• Investment:

  • • Interest rates: Interest rates affect the cost of borrowing money. Higher rates, less investment (and vice versa).

    • Business confidence in the economy: Low in recessions, high in booms. Higher confidence, more investment (and vice versa). 

    • Technology: Firms want to remain up to date. More technological advances, more investment (and vice versa).

    • Business taxes: More taxes, less money to invest, less investment (and vice versa).

    • Level of corporate debt: More debt, less money to spend, less investment (and vice versa).

• Government Expenditure:

  • • Political priorities: Elected governments tend to do things that gets them re-elected rather than what's best for the economy. 

    • Economic priorities: Economics is quite subjective so economists have different interpretations for how to run the country.

• Net Exports: 

  • • Income of trading partners: The more other countries earn, the more goods and services they will buy from you, increasing your net exports (and vice versa).

    • Exchange rates: If your country's currency devalues, your goods and services are cheaper to other countries, so they will buy more from you, increasing your net exports. Furthermore, foreign goods and services will be more expensive to you, so you will buy less, decreasing imports, increasing net exports. 

    • Trade policies: More taxes and quotas on imports will decrease imports, increasing net exports (and vice versa).