Aggregate Demand (AD) = C + I + G + (X – M)
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Question
What are the determinants of Aggregate demand?
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Solution
Aggregate demand refers to the total demand for all goods and services in an economy at a given overall price level and in a given period of time. The main determinants are:
- Consumer Spending (C): The total expenditure by households on goods and services. It depends on factors such as disposable income, savings, taxation, interest rates, and consumer confidence.
- Investment Spending (I): The expenditure by businesses on capital goods like machinery, buildings, and technology. It is influenced by interest rates, business expectations, and the availability of credit.
- Government Expenditure (G): Spending by the government on public goods and services like education, defence, and infrastructure. It directly increases aggregate demand.
- Net Exports (X–M): The difference between exports and imports. When exports exceed imports, aggregate demand rises, and when imports exceed exports, it falls.
- Monetary and Fiscal Policies: Expansionary monetary or fiscal policies (like lowering taxes or increasing the money supply) tend to increase aggregate demand, while contractionary policies decrease it.
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