Macroeconomic Factors Affecting Aggregate Demand
(a) 4% Fall in UK Household Consumption Expenditure
A fall in household consumption means that C decreases, which is a component of aggregate demand:
AD = C + I + G + (X − M)
Therefore, aggregate demand decreases and the AD curve shifts left from AD₁ to AD₂. The new equilibrium has:
- Lower real GDP: Y₂ < Y₁
- Lower price level: P₂ < P₁
This is because lower consumption reduces firms’ sales and therefore reduces the level of output demanded in the economy.
(b) Fall in UK Bank Base Interest Rates to 0.5%
A large fall in interest rates makes borrowing cheaper and reduces the incentive to save. This is likely to increase consumption and investment. As C and I increase, aggregate demand increases, so the AD curve shifts right from AD₁ to AD₂. The new equilibrium has:
- Higher real GDP: Y₂ > Y₁
- Higher price level: P₂ > P₁
The increase in aggregate demand causes an expansion in real output and upward pressure on the general price level.
(c) Fall in US Income Taxes
A reduction in income tax increases households’ disposable income. This gives households more income available for consumption, causing consumption to increase. Since consumption is a component of AD, aggregate demand increases. Therefore, AD shifts right from AD₁ to AD₂. The new equilibrium has:
- Higher real GDP
- Higher price level
The increase in consumption boosts demand for goods and services, encouraging firms to increase production.
(d) 40% Fall in London Stock Exchange Prices
A large fall in share prices reduces the financial wealth of households and investors. This can reduce consumer confidence and cause households to decrease their consumption expenditure. As C falls, aggregate demand decreases. Therefore, AD shifts left from AD₁ to AD₂. The new equilibrium has:
- Lower real GDP
- Lower price level
The fall in wealth reduces consumption and therefore reduces the level of aggregate demand in the economy.
(e) Russia’s Household Savings Ratio Rises to 7%
The savings ratio measures the proportion of household income that is saved rather than spent. An increase from 4% to 7% means households are saving a greater proportion of their income; therefore, consumption expenditure falls. Since consumption is a component of aggregate demand, AD decreases. The AD curve shifts left from AD₁ to AD₂. The new equilibrium has:
- Lower real GDP
- Lower price level
The increased desire to save reduces current consumption and therefore reduces aggregate demand.
(f) Japanese Government Increases Spending
Government spending (G) is directly one of the four components of aggregate demand. Therefore, an increase in government spending causes AD to increase. The AD curve shifts right from AD₁ to AD₂. The new equilibrium has:
- Higher real GDP
- Higher price level
There may also be a multiplier effect. The initial increase in government spending becomes income for other economic agents, who may then increase their own consumption. Consequently, the final increase in national income can be greater than the initial increase in government spending.
(g) Sterling Falls 16% Against Trading Partners
A fall in the value of sterling is a depreciation of the pound. This makes UK exports relatively cheaper for foreign consumers, while imports become relatively more expensive for UK consumers. Therefore:
- Exports are likely to increase.
- Imports are likely to decrease.
- Net exports (X − M) increase.
Since net exports are a component of AD, aggregate demand increases. Therefore, AD shifts right from AD₁ to AD₂. The new equilibrium has:
- Higher real GDP
- Higher price level
The increase in net exports increases demand for UK-produced goods and services, encouraging an increase in domestic output.