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Exploring Economics 7th Edition

Exploring Economics (7th Edition)

Book Edition7th Edition
Author(s)Sexton
ISBN9781285859439
PublisherCengage Learning
SubjectEconomics
Section 22.1: The Determinants of Aggregate Demand
In Text Question
Section 22.3: Shifts in the Aggregate Demand Curve
In Text Question
Chapter 22, Section 22.1, In Text Question, Exercise 01
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What are four major components of aggregate demand?

Explanation

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Answer

Aggregate demand is a macroeconomic term that measures the total demand in the economy at a certain time over a set period. In fact, Gross Domestic Product (GDP) is very similar.

It is the total (final) expenditure of all the units of the economy, i.e., households, firms, government, and the rest of the world.

Aggregate demand is made up of four components - consumption, investment, government spending, and net exports (exports - imports).

AD = C + I + G + (X - M)

 

Household consumption expenditure (C)

  • It comprises a household's expenditure on the consumption of goods and services.
  • These goods can be durable, semi-durable, or non-durable.
  • Consumption of households depends upon their disposable income and MPC.

Investment expenditure (I)

  • It refers to the expenditure incurred by firms on the purchase of capital goods like machines, plants, equipment, etc., to increase the production capacity.
  • Investment decision depends upon the relative values of MEI (Rate of return/Marginal efficiency of investment) and rate of interest.

Government expenditure (G)

  • It refers to expenditure incurred by the government on the purchase of consumer goods and capital goods to satisfy the collective wants of the society. Example: public parks, public hospitals, roads, etc.
  • Government expenditure depends upon the priorities of the government.

Net exports (X - M)

  • It is the difference between exports and imports.
  • It reflects the net demand for a domestic product by the rest of the world.
  • Net exports depend upon many things like foreign trade policy, foreign exchange rate, comparative prices,  quality, etc.
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