Aggregate Demand and Its Components

• Simple Keynesian model says: in the short run, an economy’s total income depends on desired aggregate demand or aggregate spending of people.
• More desired demand → more goods and services sold → more output, more workers employed, higher national income.
• Keynesian theory explains income and employment both at full employment and at unemployment level.

• Other variables remain constant (Ceteris Paribus).
• Price level is fixed.
• Rate of interest is constant.

• Ex-ante (Desired Demand): Planned or intended expenditure on goods and services.
• Ex-post (Effective Demand): Actual expenditure on goods and services.
• Desired and actual demand may differ due to unplanned inventory changes.
• They are equal only at equilibrium.
• Income determination uses Ex-ante values, whereas National Income Accounting uses Ex-post values.

Aggregate demand (AD) is the total planned spending on domestically produced final goods and services in an economy during a given period.

AD = C + I + G + (X − M)

Where:

• AD: Aggregate demand or aggregate expenditure (total planned spending).
• C: Desired consumption expenditure by households.
• I: Desired investment expenditure by firms.
• G: Desired government expenditure on goods and services.
• X: Exports of goods and services (what foreigners buy from us).
• M: Imports of goods and services (what we buy from other countries).
• (X – M): Net exports (exports minus imports).

• Consumption (C): Household expenditure on goods and services; mainly depends on disposable income.
• Investment (I): Planned expenditure on capital goods, inventories and residential houses; mainly depends on the rate of interest. Government
• Expenditure (G): Government spending on consumer and capital goods.
• Net Exports (X − M): Exports minus imports; influenced by exchange rate and trade policy.

In a simple closed economy (no government and foreign sector):

AD = C + I

Consumption and investment have different determinants and are studied separately.

• Aggregate demand is the value of total expenditure on all goods and services in an economy during a fiscal year.
• AD depends on level of employment or output in the economy.
• There is a direct (positive) relationship: AD rises with employment and falls when employment declines.
• Aggregate demand is the summation of consumption and investment.

• Short‑run national income in Keynesian theory is determined by desired aggregate demand or aggregate spending.
• Aggregate demand can be viewed as desired (ex‑ante) demand and effective (ex‑post) demand.
• In a two‑sector closed economy, AD consists of consumption and investment: AD = C + I.
• In a four‑sector economy, AD = C + I + G + (X – M).
• Ex‑ante and ex‑post concepts apply to macro variables like consumption, investment and output and are essential for understanding income determination.