Question

Write explanatory answer:

What is Aggregate demand ? Explain the determinants of Aggregate demand.

Answer 1

Meaning: -It is the total demand for goods and services in the economy during a given period of time, and at a given price level. It measures total spending by all the different sections in the economy. i.e. consumers, business units, and government.

Aggregate Demand Consists of the following Components:

C stands for Consumption Demand

I  Stands for Investment Demand

G stands for Government Demand

(X-M) stands for Foreign Demand

Symbolically, Aggregate Demand can be expressed as Aggregate Demand = C+I+G+ (X-M)

The main components of Aggregate demand are explained as follows:

1. Consumption Demand: -Consumption demand is a part of Aggregate demand. It refers to the Consumption Expenditure incurred by consumers in the economy. It is the total demand for goods and services in a given period of time.

The Consumption Expenditure may be

(a)   Autonomous Consumption Expenditure, which is incurred even when the income is zero. It is incurred irrespective of the size of income. For instance, expenditure on the basis of borrowings.

(b)   Induced Consumption Expenditure, which is incurred depending on the level of income.

The main determinants of consumption demand are as follows: -

• Level of house hold income
• Disposable income
• Stock of wealth
• Credit facility etc..

2. Investment Demand: -It is also referred as ‘investment expenditure’. It is incurred by private firms on capital good such as buildings, machines, etc. such expenditure leads to capital formation in the country. The investment expenditure can be of several types (a) Gross and Net Investment (b) Autonomous and Induced Investment (c) Financial and Real Investment.

The main determinants of Investment demand are as follows:

• Level of Savings
• Change in Demand
• Change in price Level
• Government policies etc..

3. Government Demand: - Many countries in the world have accepted the concept of welfare state. S a result, there has been rapid increase in government expenditure, which constitutes an important part aggregate demand. It may be of two types (a) Consumption Expenditure by the Government (b) Investment Expenditure by the Government
4. Foreign Demand: -(X-M) Foreign demand is a part of aggregate demand. Demand for a home country’s goods and services from foreign countries are known foreign demand. It is usually measured as the difference between exports(X) and imports (M) i.e (X-M). The foreign demand can be positive when exports are more than imports. It can be negative when exports are less than imports.

The main determinants of Foreign demand are as follows:

• Import and Export policy of the trading country.
• Foreign exchange rate

Prices of goods and services in different countries. Etc.