Download Defining Aggregate Demand and Aggregate Supply

Defining Aggregate Demand and Aggregate Supply
First of all we need to start by defining Aggregate Demand itself.
Aggregate Demand can be defined as the total demand in the economy for
goods and services at a given time. The formula for Aggregate Demand is
important in that is allows us to look at Aggregate Demand in detail.
AD = C + I + G + (X-M)
Before we move on we must define the components of this formula. AD
is the Aggregate Demand. C is the level of consumption in the economy
by consumers. I is the investment that occurs in the economy, done
mainly by firms. G is the level of Government investment in the
economy. X is the level of exports in the economy, while M is the level of
imports in the economy. Now the arrangement of the formula is
important too.
Firstly we can see that C, I, G and X are positive while the M component is
negative. This is because the consumption level will have a positive effect
since consumer buying goods raises the money flow in the economy.
Investment will also have a positive effect since more companies investing
will raise the level of money available as more companies buying factories
will have a positive effect since they will be able to buy bricks to build the
factory raising demand for bricks. Government expenditure has a positive
impact since it means that for example consumers will have more money
to spend if G is in the form of benefits. Exports, X. has a positive impact
since foreign countries buying the products made by the UK for instance
will raise the money flow in the UK. M, imports, however a negative
impact has since the level of money inside the UK will fall as it flows
abroad due to the purchasing of foreign goods.
Aggregate Supply is total level of goods and services produced by the
home country. The intersection of both Aggregate demand and
Aggregate supply is shown below.
Price
level
AS
AD
Real GDP
The intersection is the current level of output of services and goods in a
country. The Aggregate demand and Aggregate supply can be influenced by
supply side policies and demand side policies. These are policies such as
Education and Training, Research and Development, Breaking Trade Union
Powers, Benefits Reform, Welfare Reform, Labor Market Reform. We can
analyse each one.
Education and Training means that more money is invested by the
government into the economy. This is done through investment into
schools and other projects. Money can be given to local councils to invest
into Schools for redevelopment. The government can also invest in
training workers. For instance unemployed workers may be trained by
producing more programs such as skills classes to improve the skills of
workers so that they can be reemployed.
Research and development can be both done publicly and privately. The
government can invest in science and projects like this to improve
technology. Private companies can also do this to improve the productivity
of its workforce.
Trade unions are a big issue in influencing Aggregate supply and labor
force. By reducing the trade union power, workers may have lower rights,
work longer hours, and at a cheaper wage cost. This will raise the
productivity of the work force.
Benefits are given to those who are currently unemployed and are in the
process of looking for work through job agencies. A reform of the benefits
system means that there will be lower benefits paid out or the time period
of benefits is reduced. This means that workers are more inclined to go to
work raises the level of goods and services produced in the economy.
Demand side policies affect the level of Aggregate demand in the
economy. This can be analysed by looking at the formula AD = C + I + G +
(X-M). A rise in C, I, G and X, while a fall in M would all raise the level of
aggregate demand. Consumption could be influenced by lowering the
interest rates for instance. This would make it cheaper for the consumers
to borrow money on loans rising their spending through loan money. It
also means that the savings rate will also fall, reducing the reward for
saving, lowering savings in the bank and thus raising the level of money
spent on consumer goods. The Government could also raise the level of
invested it puts into the economy. This could be money taken from tax
for instance and could then be reinvested into the economy. Lower
interest rates could also encourage businesses to invest since the lower
interest means that they too will borrow more money to fund
investment into factories. Exports can be raised by subsidizing companies
that export goods, making it cheaper for them to export and also be
more competitive abroad. Imports can be affected through the use of
quotas.