- Aggregate demand
- Aggregate demand is the total spending on a country's domestically produced goods and services at each price level.
- Aggregate supply
- Aggregate supply is the total quantity of output, or real GDP, that firms will produce and sell at each price level.
The four components of aggregate demand
Can you name the four components of aggregate demand?
AD = C + I + G + (X − M). Each letter is one kind of spending on UK output.
Consumption is spending by households on goods and services for their own use, and it is the largest component of aggregate demand.
Can you think of an example?
A family in Leeds buys groceries, pays for haircuts and books a week in Devon. All of it is consumption. Because it is by far the largest part of AD, a small percentage change in it moves AD a long way.
Investment is spending on new physical capital, such as factories, machinery and equipment, mainly by businesses.
Can you think of an example?
A haulier buys a fleet of electric lorries and a chip maker builds a new plant. Both are investment. It swings more than consumption, rising and falling with firms' confidence about future sales.
Government spending is the government's purchases of goods and services produced in the economy, which leaves out the pensions and benefits it pays.
Can you think of an example?
The Ministry of Defence orders new ships, a council builds a primary school, and the state pays teachers' salaries. All three are purchases of goods and services, so all three count as government spending, G.
Net exports are exports minus imports, so they add to aggregate demand when exports are larger and reduce it when imports are larger.
Can you think of an example?
Buyers abroad spend £30 billion on UK goods and services, and UK residents spend £35 billion on goods made abroad. Net exports are £30bn − £35bn = −£5 billion, which pulls AD down.