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Determinants of Aggregate Demand
Determinants of Aggregate Demand
Aggregate demand: The total value of final goods and services that consumers, businesses, government, and those living outside of the country, are willing and able to buy at various price levels.
Increase in wealth
When there is an increase in wealth, there is an increase of aggregate expenditures and an increase in aggregate demand.
Increase in age of durable goods
When there is an increase in the age of durable goods, there is an increase in the aggregate expenditure and an increase in aggregate demand. Durable goods are the more expensive items that are long lasting, that are most commonly used by households. (Ex. Furniture, cars, and electronics)
Consumers are pessimistic about future
When consumers are pessimistic about the future then the aggregate demand decreases. Consumers confidence influences consumption. If consumers are confident that income and wealth will increase in the future, current consumption will rise. If consumers fear a job loss or a recession, current consumption will fall.
Increase in interest rates
When the interest rates increase, it costs more to borrow money because of the price increase. Increase in interest rates reduce investments such as consumer purchases as new homes or cars. When there is an increase in interest rates, the businesses investment spending is decreased , the aggregate expenditures decrease, and so does the aggregate demand. When investment spending is up, aggregate expenditure is increasing as well as the aggregate demand. An increase in the age of capital goods tends to increase investment spending as we replace or fix the aging capital goods.
Increase in spare capacity
When there is an increase in spare capacity there is an decrease in aggregate demand. Output can be increased without new investment if spare capacity exists. More excess capacity in the economy means a lower level of investment spending.
Increase in government regulation
When there is an increase in government regulation there is an decrease in investment spending, a decrease in aggregate expenditures that results in a decrease in aggregate demand. Trade restrictions imposed by governments limit the amount of exports and/or imports.
Firms pessimistic about future
When firms are pessimistic about the future aggregate demand decreases. The level of business investment depends on the profitability of investments, which depend on interest rates, technology, the cost of capital goods, and excess capacity.
Canadian dollar appreciates
When the Canadian dollar appreciates imports are rising, exports are declining, and aggregate expenditures and aggregate demand are both decreasing. When the domestic currency depreciates on the foreign exchange market, domestic goods become cheaper to foreign buyers and exports will increase. Imports will decrease at the same time because the change in the exchange rate will make foreign goods more expensive for domestic buyers.
Increase in Price of Domestic Good
When there is an increase in the price of a domestic good there is a decrease in our aggregate demand. Higher Canadian prices cause domestic consumers to buy more imports and fewer Canadian goods. Foreign buyers respond similarly, shrinking Canadian exports.
Increase in price of foreign goods
When there is an increase in the price of foreign goods imports tend to decrease due to the fact that it is more expensive to buy goods from other countries. Exports begin to increase since other countries begin to buy from different countries which sell cheaper goods. This in return causes aggregate expenditure and aggregate demand to increase. Changes in the relative prices of foreign and domestic goods will cause an increase in net exports. These are changes in the overall price level creating a movement along the aggregate demand curve.
Decrease in preference for Canadian goods
When there is a decrease in preference for Canadian goods there is an increase in imports since we buy more foreign goods and less Canadian goods. There is a decrease in exports because less countries like our goods and buy from other countries. As well aggregate expenditures and aggregate demand start to decrease. If buyers find that they “like” a good move, then their demand increases. If buyers find that they “like” a good less then their demand decreases.
When aggregate demand decreases because of less spending form the household or business sectors, this is when the government sector begins to spend more to counter the decreasing aggregate demand. When the government spending increases this in turn causes aggregate demand to increase which causes inflation. Alternatively, if aggregate demand increases to the point of triggering inflation, then the government is likely to spend less.
Increase in age of capital goods
When investment spending is up, aggregate expenditure is increasing as well as the aggregate demand. An increase in the age of capital goods tends to increase investment spending as we replace or fix the aging capital goods.
This is when the bank controls the interest rates in order to control the money supply. When the interest rate is low (or decreasing), aggregate demand is increasing because there are more loans being taken at because of the low interest rates. When the money supply is increasing then the aggregate demand is also increasing because there is a larger money supply to spend therefore forcing aggregate demand to rise.
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