Aggregate Demand And Supply

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AGGREGATE DEMAND AND SUPPLY AGGREGATE DEMAND:- Aggregate demand is the amount which will be spent at different values of the price level. It is composed of consumption (C), investment (I), government spending (6) and net exports (X—M). THE AGGREGATE DEMAND CURVE:- The aggregate demand curve shows the quantity of goods and services which households, firms, overseas buyers and government are prepared to buy at different values of the general price level. It is drawn on the assumption that other things (e.g. the money supply, rates of taxation, the marginal propensity to consume) remain unchanged. Figure 28. I shows an aggregate demand curve. WHY THE ADCURVE SLOPES DOWN FROM LEFT TO RIGHT:- There are three main reasons why there is an inverse relationship between the general price level and aggregate demand and hence why the AD curve slopes down from left to right. • A rise in the price level reduces the real value of people’s income and wealth and hence decreases their ability to consume. • Higher prices increase people’s and firms’ demand to hold money for transactions purposes. This increase in the transactions demand for money is likely to raise the rate of interest and thereby reduce demand for consumer goods (consumption) and demand for capital goods (investment). • An increase in the general price level will make domestic goods and services less competitive against foreign goods and services. This will reduce demand for domestic products from both domestic and foreign consumers. MOVEMENTS ALONG THE DEMAND CURVE:- As with a demand curve for a particular product, the cause of a movement along an aggregate demand curve will be a change in price, in this case a change in the general price level. A... ... middle of paper ... ...curs at the full employment level. However they argue that it occurs at less than full employment but where shortages in resources are beginning to be experienced, both output and the general price level will rise or if it occurs at a low level of economic activity it will cause a rise solely in output. Figure 28. 14 shows an increase in aggregate demand raising output but having no effect on the general price level. THE IMPORTANCE OF INVESTMENT:- Investment is a component of aggregate demand. So an increase in investment will shift the aggregate demand curve to the right which will stimulate economic activity. Investment not only influences aggregate demand; it also affects long run aggregate supply. An increase in investment raises the productive potential of the economy. So investment generates demand and creates some of the resources to meet that demand.

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