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Aggregate Demand and Aggregate Supply Notes

1. Aggregate Demand
2. Aggregate Supply

Aggregate Demand

Aggregate Demand refers to the total value of all final goods and services that are planned to buy by all the sectors of the economy at a given level of income during a period of time. AD represents the total expenditure on goods and services in an economy during a period of time.

Components of Aggregate demand are:

1. Household consumption expenditure (C).
2. Investment expenditure (I).
3. Govt. consumption expenditure (G).
4. Net export (X – M).

Thus, AD = C + I + G + (X – M)

In two sector economy AD = C + I

Aggregate Supply

Aggregate Supply is the money value of all final goods and services available for purchase by an economy during a given period. It is the flow of goods and services in the economy. Since, the money value of final goods and services is equal to net value-added, AS is nothing but the national income.

AS = C + S

Aggregate supply represents the national income of the country. AS = Y (National Income). The main components of aggregate supply are two, namely, consumption and saving. A major portion of income is spent on the consumption of goods and services and the balance is saved. Thus, national income (Y) or aggregate supply (AS) is the sum of consumption expenditure (C) and savings (S).

Aggregate supply is the money value of total output available in the economy for purchase during a given period. When expressed. In physical terms, aggregate supply refers to the total production of goods and services in an economy. It is assumed that in the short run, prices of goods do not change and the elasticity of supply is infinite.

👉Demand: Definition, Importance, Types, Factors, Law, Demand Schedule

👉Supply: Definitions, Determinants, Laws, Elasticity

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Aggregate Demand Components

Aggregated demand means the total demand for final goods & services in an economy. It is actually Total (Final) Expenditure of all the units of the economy i.e. Households, Firms, Government & Rest of the World

The Various Components of Aggregate Demand:

AD = C + I + G + (X-M)

1. Private (Household) Consumption Expenditure (C)
2. Investment Expenditure (I)
3. Government Expenditure (G)
4. Net Exports (X-M)

Private (Household) Consumption Expenditure (C)

It comprises of households’ expenditure on the consumption of goods and services. These goods can be durable, semi-durable or non-durable. Consumption of households depends upon their Disposable Income & MPC.

Investment Expenditure (I)

It refers to the expenditure incurred by firms on the purchase of capital goods like machines, plant, equipment, etc. to increase the production capacity. Investment decision depends upon the relative values of MEI (Rate of Return) & ROI (Rate of Interest).

Government Expenditure (G)

It refers to expenditure incurred by the government on the purchase of consumer goods and capital goods to satisfy the collective wants of the society. For example– Public parks, hospitals, Roads, etc. Government expenditure depends upon the priorities of the government.

Net Exports (X-M)

It is the difference between exports and imports. It reflects the net demand for a domestic product by the rest of the world. Net exports depend upon many things like Foreign Trade Policy, Foreign Exchange Rate, Comparative Prices & Quality, etc.

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Types of Investment

Following are two types of investment explained below:

1. Induced Investment
2. Autonomous Investment

Induced Investment

Real investment may be induced. Induced investment is profit or income motivated. Factors like prices, wages and interest changes that affect profits influence induced investment. Similarly, demand also influences it. When income increases, consumption demand also increases and to meet this, investment increases. In the ultimate analysis, induced investment is a function of income i.e., I = f(Y). It is income elastic. It increases or decreases with the rise or fall in income.

Autonomous Investment

Autonomous investment is independent of the level of income and is thus income inelastic. It is influenced by exogenous factors like innovations, inventions, growth of population and labour force, research, social and legal institutions, weather changes, war, revolution, etc.

But it is not influenced by changes in demand. Rather, it influences the demand. Investment in economic and social overheads whether made by the government or the private enterprise is autonomous. Such investment includes expenditure on building, dams, roads, canals, schools, hospitals, etc. Since investment in these projects is generally associated with public policy, autonomous investment is regarded as public investment.

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Some Important Factors Aggregate Demand and Aggregate Supply Notes

Some important factors aggregate demand and aggregate supply notes:

1. Ex-Ante Savings
2. Ex-Ante Investment
3. Ex-Post Saving
4. Ex-Post Investment
5. Equilibrium Level
6. Full Employment
7. Voluntary Unemployment
8. Involuntary Unemployment
9. Under Employment
10. Investment Multiplier
11. Excess Demand
12. Inflationary Gap
13. Deficient Demand
14. Deflationary Gap

Ex-Ante Savings

Ex-Ante Savings: Ex-ante saving refers to the amount of savings that all the households intended to save at different levels of income in the economy at the beginning of the period. It is also known as planned savings.

Ex-Ante Investment

Ex-Ante Investment: Ex-ante investments refers to the amount of investment that all the firms plan to invest at a different level of income in the economy at the beginning of the period. It is also known as planned investment.

Ex-Post Saving

Ex-Post Saving: Ex-post savings refer to the actual or realised savings in an economy during a financial year at end of the period.

Ex-Post Investment

Ex-Post Investment: Ex-post investment refers to the actual or realised investment in an economy during a financial year at the end of the period.

Equilibrium Level

The equilibrium level of income is determined only at the point where AD = AS or S = I, .i.e. the flow of goods and services in the economy is equal to the demand for goods and services. But it cannot always be at full employment level also as it can be at less than full employment.

Full Employment

Full employment is a situation when all those who are able and willing to work at the prevailing wage rate, get the opportunity to work.

Voluntary Unemployment

Voluntary unemployment is a situation where the person is able to work but not willing to work at the prevailing wage rate.

Involuntary Unemployment

Involuntary unemployment is a situation where the worker is able and willing to work at the prevailing wage rate but does not get work.

Under Employment

Underemployment is a situation where all those who are able to work at existing wage rates, are not getting jobs. It refers to that situation in the economy where AS = AD or S = I, but without fuller utilisation of labour force.

Investment Multiplier

Investment multiplier (K) is the ratio of change in income (ΔY) due to change in investment ΔI.

K = ΔY ÷ ΔI or K = 1 ÷ 1-MPC or K = 1 ÷ MPS

Value of investment multiplier lies b/w 1 to-infinitive.

Excess Demand

Excess demand refers to a situation when aggregate demand exceeds aggregate supply corresponding to full employment.

Inflationary Gap

Inflationary gap is the gap by which actual aggregate demand exceeds the level of aggregate demand required to establish full employment. It measures the extent of excess demand.

Deficient Demand

Deficient Demand: When AD falls short of AS at full employment it is called deficient demand. In other words, AD < AS at the level of full employment. It is called deficient demand.

Deflationary Gap

The deflationary gap is the gap by which actual aggregate demand is less than the level of aggregate demand required to establish full employment. It measures the extent of deficient demand.

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