1. Aggregate Demand
Year 1 Economics

2. Meaning and Measurement of Aggregate Demand
• Aggregate Demand (AD) =
• Total level of planned real expenditure on goods and services
produced within a country in a given time period
• The components of aggregate demand are:
• Household spending on goods and services (C)
• Gross Fixed Capital Investment Spending (I)
• Value of the Change in Stocks (Inventories) (I)
• Government Spending on Public Services (G)
• Exports of Goods and Services (X)
• (minus) Imports of Goods and Services (M)
• GDP (expenditure-based) is the actual value of expenditure
• Changes in AD are key to understanding fluctuations in a cycle
e.g. recession and recovery, boom and slowdown stages

3. The Components of Aggregate Demand (AD)
Source: HM-Treasury Databank
Consumption
(C)
Government
Spending (G)
Investment
(I)
Exports
(X)
Imports
(M)
Year £m £m £m £m £m
2007 1,021 326 294 477 538
2008 1,016 333 281 485 528
2009 982 337 240 445 476
2010 987 337 254 472 518
2011 985 337 260 499 523
2012 1,000 345 262 502 539
2013 1,018 344 271 510 547
2014 1,044 349 294 512 560
2015
Consumption is the biggest component of aggregate demand

4. Growth of UK Aggregate Demand 2007-2015
Source: HM-Treasury Databank
Consumption
(C)
Government
Spending (G)
Investment
(I)
Exports
(X)
Imports
(M)
Year Per cent Per cent Per cent Per cent Per cent
2007 2.8 1.2 5.3 -2.1 -0.8
2008 -0.5 2.0 -4.7 1.6 -1.8
2009 -3.3 1.2 -14.4 -8.2 -9.8
2010 0.5 0.0 5.9 6.2 8.7
2011 -0.1 0.0 2.3 5.6 1.0
2012 1.5 2.3 0.7 0.7 3.1
2013 1.7 -0.3 3.4 1.5 1.4
2014 2.6 1.6 8.6 0.5 2.4
2015

5. Aggregate Demand – A Contraction of AD
General
Price Level
Real GDP
AD =
C+I+G+(X-M)
GPL1
Y1Y2
GPL2
GPL3
Y3
A rise in the price level causes a
contraction of AD

6. Aggregate Demand – An Expansion of AD
General
Price Level
Real GDP
AD =
C+I+G+(X-M)
GPL1
Y1Y2
GPL2
GPL3
Y3
A rise in the price level causes a
contraction of AD
A fall in the price level
causes an expansion of AD

7. Understanding why the AD Curve Slopes Downwards
Real
incomes
• As the price level falls, the real value of income rises
and consumers are more able to buy what they want
or need – this is known as the real balance effect
Balance of
trade
• A persistent fall in the relative price of level of
Country X could make foreign-produced goods and
services more expensive, causing a rise in exports
and a fall in imports – the trade balance will improve
Interest
rate effect
• If price inflation is low and this leads to a reduction in
interest rates, there is less incentive to save and a fall
in interest rates may also cause the exchange rate to
depreciate – helping to improve export sales

8. Shifts in the Aggregate Demand Curve (AD)
General
Price Level
Real GDP
AD1
GPL1
Y1
AD2
Y2
AD3
AD1 – AD2: Outward
shift – will raise national
output at all price levels

9. Shifts in the Aggregate Demand Curve (AD)
General
Price Level
Real GDP
AD1
GPL1
Y1
AD2
Y2
AD3
Y3
AD1 – AD2: Outward
shift – will raise national
output at all price levels
AD1 – AD3: Inward shift
– will reduce national
output at all price levels

10. Examples of Shifts in Aggregate Demand
Fall in AD
Fall in net exports (M>X)
Cut in government
spending (G)
Higher interest rates
Decline in household
wealth and confidence
Increase in AD
Depreciation of the
exchange rate
Cuts in direct and indirect
taxes
Increase in house prices
Expansion of supply of
credit + lower interest rates

11. Changes to Monetary Policy
• Changes in official monetary policy interest rates
• Change in the supply of money and credit
• Change in the value of a country’s exchange rate
Changes to Government Fiscal Policy
• Changes in the level of direct / indirect taxes
• Changes in government (state) spending
• Changes in government (fiscal) borrowing
Business and Consumer confidence
• Planned capital investment spending by businesses
• Consumer confidence and retail spending
Key Causes of Shifts in Aggregate Demand

12. External Shocks to Aggregate Demand
Many unexpected events cause changes in demand, output and
employment. These events are called external “shocks”
A large rise or fall in the value of the exchange rate
A recession, slowdown or boom in one or more of a nation’s key
trading partner countries
A slump in the housing market / construction sector of a country
An event such as the Global Financial Crisis which caused a fall in
the supply of credit available to businesses and households
A large change in commodity prices for a country that
is a commodity exporter

13. Exports of Goods and Services (X)
Relative Prices
of exports in
World Markets
The exchange
rate – a
stronger
currency makes
exports more
expensive
Non-Price
Demand
Factors e.g.
Design and
Branding
Strength of
Aggregate
Demand in Key
Export Markets
Exports are goods and services sold to other countries. Exports are
an injection into a nation’s circular flow of income and spending
Many factors affect the
level of demand for a
nation’s exports – some of
these are shown on the left

14. UK Car Export Markets
The UK remains a large exporter of cars to the rest of the world.
Here is data on the main export markets for UK manufacturers
Cars exported from the United Kingdom (UK) 2014 (per cent of total exports)
EU 53.1
China 11.5
US 8.8
Russia 6.8
Turkey 2.1
Australia 1.9
Japan 1.4
Israel 1.3
Switzerland 1
South Korea 1
Canada 1

15. The Net Trade Balance (X-M) and Aggregate Demand
The net trade balance is measured as the value of exported goods
and services minus the value of imported products
A trade surplus means
that X>M – therefore
aggregate demand (AD)
will increase
A trade deficit means
that M>X – therefore
aggregate demand will
fall
If X=M, then the trade
balance is zero, external
trade will have a
neutral effect on AD 0
50
100
150
200
250
300
350
400
450
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
TradebalanceinbillionU.S.dollars
Balance of Trade for China 2000-2014

16. • Public sector debt is owed by central and local
government and by public (state-owned) corporations
• Debts owed by state-owned banks are included in the figures
for national debt
• Private sector debt is owed by private businesses and
households.
• Companies / businesses may have borrowed to finance
investment (corporate sector debt)
• Households have loans for example credit card debt, retail
store card debt and mortgages on properties
• Financial debt is also part of the private sector – this is
the outstanding (unpaid) debts of banks and financial
corporations - for example the level of bad debts on
loans to businesses and to the housing market
Public and Private Sector Debt

17. • In 2013, household and non-
financial firms’ debt amounted to
208% of UK GDP – down to levels
last seen in mid-2007, but
significantly higher than they were
a decade ago (170pc of GDP) and
15 years ago (128pc of GDP).
• The UK private debt/GDP ratio is
high by historical and international
standards, and well above the
160% level used by the EU
Commission as a threshold for
gauging imbalanced debt to income
levels for EU member states.
The Scale of Debt in the UK Economy

18. UK Household Debt Relative to Disposable Incomes
60
70
80
90
100
110
120
130
140
150
160
1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Short-term Loans
Long-term Loans
Stock of outstanding loans to households, % of households’ disposable income
• Short term loans include outstanding debt on credit cards
• Long term loans include mortgage debt

19. • Debt acts as a constraint on future spending power
• Millions of people in the UK are saddled with many thousands
of pounds of debt and the interest payments on this debt
reduces their effective disposable income
• Commercial banks also have high debt and this restricts their
ability to make fresh loans to businesses and households who want
to borrow. This can limit business investment
• The economy can be at risk with a high debt-to-GDP ratio
• If price deflation happened, falling consumer prices and
incomes would make the debt problem worse in real terms
• When nominal interest rates rise even by just a modest
amount, then many households – especially mortgage payers -
are at risk and can struggle to meet repayments. This could
cause a slowdown or a possible recession in the housing
market.
Consequences of Debt for an economy such as the UK

20. Aggregate Demand
Year 1 Economics