Aggregate Demand & Its Components

AGGREGATE DEMAND

Meaning:

Aggregate demand refers to the total demand for final goods and services in the economy.

Alternatively,  aggregate demand is the total expenditure in the economy. 

Components of AD:

Thus, the main components of aggregate demand (aggregate expenditure) in a four sector economy are:

1. Household (or private) consumption demand. (C)

2. Private investment demand. (I)

3. Government demand for goods and services. (G)

4. Net export demand. (X-M)

Thus,

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

We discuss below each of the above components:

1. Household (or Private) Consumption Demand (C):

It is defined as ‘Value of goods and services that households are able and willing to buy.’ Alternatively, it refers to ex-ante (planned) consumption expenditure to be incurred by all households on purchase of goods and services. 

2. Private Investment Demand (I):

This refers to planned (ex-ante) expenditure on creation of new capital assets by private entrepreneurs.

3. Government Demand for Goods and Services (G):

It refers to government planned (ex-ante) expenditure on purchase of consumer and capital goods.

4. Net Exports (Exports-Imports) Demand:

Net export is the difference between export of goods and services and import of goods and services. 

Since determination of income (output) and employment is to be studied in the context of a two sector (Household and Firm) economy we shall, therefore, include in aggregate demand (AD) only two broad components of demand such as consumption demand (C) and investment demand (I). Put in symbols:

AD = C + I

This has been depicted in Fig.