Overview
Aggregate demand is the total amount of goods and services demanded by consumers (which can include businesses and the government) in the economy. It is one half of teh aggregate supply and demand curve view of national production.
Components of Aggregate Demand
Demand in an economy is driven by three principal agents.
- Consumers - consumers of the largest portion of aggregate demand in the economy. A sizable portion of consumer spending is spending that consumers can not easily curtail, however, luxury items, restaurant spending and entertainment can be cut when needed and can create fluctuations in the total.
- Businesses
- businesses expenditures
include day to day operational spending, which is required to keep the business going, and can generally be taken to be relatively fixed.
Long term capital expenditures such as investments and research and development are less stable. Business can cut back on this type of
spending when the economy appears to be weakening or some other negative forecast clouds their future outlook.
Business demand is driven by consumer demand, and in general can be more volatile. This is becuase, when cusomer demand increases by 10% (for example), busiesses will begin to produce 10% more, but also will try to increase their inventories by 10%. That is, the business response to increasing/decreasing consumer demand is magnified. (see ellis)
On the other hand, an early indicator that businesses may begin to cut back on spending is over-extended inventories. This occurs when consumers are not spending as much as businesses anticipate, causing their inventories to begin piling up. If this continues for long, businesses will cut back on production in response to the weakening consumer demand and in order to try to bring their inventory levels down. - Government
- government expenditures are typically set by law in a budget. However, there are portions of the budget that can change with changing
conditions. Unemployment payments are an example of automatic government expenditures that can increase as unemployment increases.
Social Security is one of the largest goverment programs. Spending on social security is specified by law, but tied to demographics and be predicted fairly well.
Forecasting Aggregate Demand
Forecasting aggregate demand typically utilizes the tools of time series anlaysis to identify and extrapolate trends. In addition, it can rely heavily on surveys to gauge current plans and sentiment. This might include.
- Consumer and Business Sentiment
- Unemployment
Aggregate Demand Based Policies
Fiscal policy principally works by moving the demand curve.
- Increased government spending increases demand, and reduced spending lowers it
- Tax breaks will increase demand, and tax increases will decrease demand.