Determinants of Aggregate Demand
Definition
Aggregate demand (AD): the total planned spending on a country's output at each price level, where AD = C + I + G + (X − M).
Determinant of AD: any factor, other than the price level, that raises or lowers one of these four components and so shifts the whole AD curve.
The Main Determinants
- Consumer confidence: optimistic households spend more and save less, raising C.
- Interest rates: a change in the central-bank rate alters the cost of borrowing and the reward for saving, moving C and I.
- Real disposable income and taxation: a cut in income tax leaves households more to spend, raising C.
- Household wealth: rising house and share prices make owners feel richer, raising C.
- The exchange rate: a weaker currency makes exports cheaper and imports dearer, raising (X − M).
- Conditions in trading-partner economies: faster growth abroad lifts foreign demand for a country's exports X.
- Government policy: higher government spending raises G directly, while looser monetary policy works through C and I.
Key Idea
- Every determinant acts on one component of AD = C + I + G + (X − M).
- A change in any component changes total planned spending and shifts the whole AD curve.
- Detailed theory of each component is not required in 4.3.3.
How a Determinant Shifts AD
- A determinant changes one component; a tax cut, say, raises C.
- Higher C raises total planned spending at every price level.
- Greater spending shifts the whole AD curve to the right, and the reverse shifts it left.
Example
- Suppose a central bank cuts its policy rate from 5% to 4% to revive a weak economy.
- Cheaper credit cuts repayments on a £200,000 mortgage and makes firms' investment projects more profitable.
- Higher C and I lift total planned spending, so AD = C + I + G + (X − M) rises.
- The AD curve shifts right, though the size of the shift depends on how confident households and firms feel.
Depth and Judgement
- You need to know which factors change AD, through which component, and in which direction.
- You do not need detailed theory of consumption, investment or the other components here.
- The same trigger can shift AD a lot or a little; a rate cut barely lifts C if pessimistic households repay debt instead.
Exam technique
- Name the determinant, the component it works through, and the direction AD shifts.
- Link the trigger to spending with a clear chain, for example a rate cut → higher C → AD shifts right.
Common Mistake
- Do not drift into detailed component theory that 4.3.3 does not require.
- Do not confuse a determinant, which shifts AD, with a price-level change, which is a movement along AD.
Self review
- What is a determinant of aggregate demand?
- Name four determinants and the component each works through.
- Trace the chain from a cut in interest rates to a shift in AD.
- Why does the size of an AD shift depend on confidence?
