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The determinants of the components of aggregate demand.

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Introduction

The Determinants of the Components of Aggregate Demand Aggregate Demand is the total of all demands or expenditures in the economy at any given price. It is made up of four components, which are Consumption (C), Investment (I), Government Spending (G) and Net Exports (NX). Out of these, I will be discussing the determinants of Consumption, Investment and Net Exports. Consumption or consumers' expenditure is the most important component of aggregate demand. It accounts for about 67% of UKs aggregate demand. It is the amount of money spent by individuals on durable goods such as PCs and cars, non-durable goods such as hair gel, food and drinks, and services such as the Internet and insurance. A key determinant of consumer spending is the level of disposable income, which is income after the payment of compulsory direct taxes and social security contributions. ...read more.

Middle

The MPC of very low income groups is likely to be 100% as any increase in their incomes, is likely to be spent on essential such as food, clothing and shelter. Even at living standards beyond this, it is likely that the MPC may be high - about 90%. Although it will decline a little as some of the increase in income is saved. However, when income levels are high and there is a general affluence, the MPC falls to 60-70% or so. The rest of the income is saved and adds to wealth. If incomes increase, the AD will shift to the right. A key way in which consumers may receiver more (or less) personal disposable income (PDI) ...read more.

Conclusion

The rate of interest is also an important factor in determining consumption. Consumers generally buy goods like consumer durables and housing on loan or credit. If the interest rate is high, the repayments of these consumers will go up and their PDI will reduce. This will reduce consumption and make the AD curve shift to the left, ceteris paribus. High inflation reduces consumption as households try to protect their savings against the eroding effect of price rises. Asset prices are important as well - a booming stock market or housing market encourages spending, as people feel less cautious because they know they could sell their shares and they borrow money against the rising value of their property. Consumer confidence affects consumption as well. For example, with the prospect of war, people tend to spend less and during a period of low unemployment, people will be willing to spend more. ...read more.

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