Skip to main content

Macroeconomics: components of aggregate demand

  • Consumption: purchases of durable and non-durable goods and services by domestic households
    • In the US, consumption is the largest component of aggregate demand, equaling about 70% of the nation's GDP as of 2019.
    • Determinant of consumption:
      • The level of income  determines the level of consumption. If the income level increases, consumption rises.
      • Average propensity to consume (APC)  and save (APS): at low (high) income levels the APC is high (low). This is the proportion of national income that goes to consumption. At low (high) income levels the APS is low (high).

      • Marginal propensity to consume (MPC): the change in consumption that results from a change in income.

      • Marginal propensity to save (MPS): the change in savings that results from a change in income.

      • MPS + MPC =1 in a closed economy.
      •  Wealth impacts the level of consumption. Household wealth includes assets minus liabilities.  Assets include real estate, stocks, bonds, and savings. When asset prices rise (fall), households feel richer (poorer), and tend to consumer more (less).
      • Interest rate influences the level of consumption. At higher (lower) interest rate households prefer to save (consume) and consume (save) less.
  • Investment: purchase of capital goods by firms and the purchase of a newly built houses by households. 
    • In the US, investment made up approximately 18% of GDP in 2019.
    • Determinants of investment:
      • Interest rates: high (low) interest rates, it is more (less) costly for firms to acquire new capital. There is an inverse relationship between the interest rate of a nation and the quantity of funds demanded for investment. Whereas there is a direct relationship between the (real) interest rate and the supply of funds for investment.


      • Technology: new technologies lead to an rise in demand for funds for investment. 
      • government regulation and taxes:  lower (higher) regulations by the government increase (decrease) the demand for investment.
  • Government spending: expenditure of the government on goods and services. It represented about 17% of the US GDP in 2019.
    • Determinant of government spending:
      • Fiscal policy: When the economy is growing and producing at or near full employment government spending can decrease. If the economy is contracting, government spending tends to increase.
  • Net Export: total revenue earned by exports minus total spending on imports. Net export represented -5% of the 2019 US GDP.
    •  Determinants of Net Export:
      • Foreign consumer's income: If the incomes abroad increase, exports should increase.
      • Exchange rates: If a country's currency becomes stronger (weaker) relative to its trading partners' currencies, then its exports fall (rise), lowering (increasing) net export.
      • Protectionism: the use of government policies to reduce the level of imported goods into its economy (tariffs, quotas, subsidies to domestic producers). Most economists believe that these policies reduce the overall benefit of trading.
Reference: Welker, Jason. AP Maroeconomics Crash Course. Research & Education Association (2014). p 109-118.
Labels:
Location: New York, NY, USA

Comments

Post a Comment

Popular posts from this blog

Macroeconomics: multiplier and crowding out effects

Multiplier effect: whenever   any of the components of AD increases, the increase in GDP will be greater than the initial increase in expenditures. The impact on GDP of a particular increase in spending depends on the proportion of the new income that is taken out of the system to the proportion that continues to circulate in the economy. The multiplier effect tells us the impact a particular change in one the components of AD will have on the total income (GDP).  Let k denote the spending multiplier, which is a function of MPC and MPS. The larger the marginal propensity to consume, the larger the spending multiplier. Notice that the larger the MPC, the greater the impact a particular change in the spending variables will have on the nation's GDP. The crowding out effect: If government spending increases without an increase in taxes, the government must borrow funds from the private sector to finance its deficit, thereby increasing the interest rate. This increase in interest ...
Post a Comment
Read more

Econometrics: Bivariate population model

Hello I'm finally back from my extended break. I thought that we should start studying Econometrics.  Let's begin by analyzing a simple bivariate regression. Assume that this equation describes the relationship between two variables X and Y. We say that Y is the dependent variable, whereas X is the independent variable. In other words, we assume that Y (the output) depends on X (the input). Epsilon is the error term, it represents other factors that affect Y. The error term must be uncorrelated with the variable X so that we do not need to include them in our regression, and thus the coefficient of X (beta) should not change, even though Epsilon also determines Y.  beta-0 is the constant term. It tells us what would be Y if X=0. beta-1 is the effect on Y if X changes by one unit. To see this, assume X=education is a continuous function, let's take the derivative of Y=wage with respect to X: Thus, if education goes up by one unit, we should expect, on average, wage to go up ...
Post a Comment
Read more

Exercise: short and long run effects of a fiscal policy

  You are in charge of the government budget for the year 2021. You are told that schools and public roads need to be updated, and you estimate an appropriate budget in order to carry out the task. Describe what will happen in the short run to the economy, and what type of inflation do we see? Describe the supply side effect from this policy, explain what happens in the long run. Assume that there is no crowding out effect. First, note that updating public infractures, assuming taxes stay the same, will require an increase in government spending, which will also have an impact on the investment and consumption level in the economy (remember the spending multiplier?). Therefore, the aggregate demand curve will shift to the right. This will cause inflation (i.e positive change in the price level) and a higher output in the short-run.  Note that if we were to assume a large crowding out effect, the short run aggregate supply curve would shift to the left (increase in production c...
Post a Comment
Read more