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The characteristics of AD

a) The components of AD

Aggregate demand (AD) is the sum of all spending on goods and services in an economy over a period of time and at a given price level (KEY DEFINITION).

Its components are summarised in this equation:


Where C is consumption, I is investment, G is government spending, and (X - M) is net trade (exports minus imports).

b) The relative importance of the components of AD

Consumption - This is spending by households on goods and services. In 2017 in the UK, this accounted for 66% of GDP, and is usually the largest component of AD in free market economies (1.1.6).

Investment - This is spending by firms on capital goods (remember this from 1.1.4?). In 2017 in the UK, this made up 17% of GDP. The majority of investment is from the private sector, but some is from the government.

Government spending - This is spending by the government on goods and services for the public. It includes current spending such as wages in the public sector, and investment in public goods such as roads and healthcare. It doesn't include transfer payments, such as Job Seeker's Allowance, as this money is just transferred from taxing one group of people to provide welfare payments for another. In 2017, this was 18.6% of UK GDP. In a command economy, this makes up most of AD.

Net trade - This is exports minus imports. In the UK, we are a heavily import dependant country, resulting in a trade deficit. In 2017, exports accounted for 28.5% of GDP, and imports stood at -30.3% (a negative value as this money leaves the country).

c) The AD curve

The AD curve uses the same concept as the demand curve in microeconomics, however instead of plotting quantity against price, the AD curve plots real GDP/output against the general price level.

The general price level is measured in the UK using the consumer price index. A rise in this means that there is inflation in the economy.

A rise in prices causes a fall in real GDP, as the AD curve is downward sloping.

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d) Movements and shifts of the AD curve

A movement along the AD curve is when there is a change in the point at which the economy is in equilibrium with the general price level and real GDP. This is ONLY caused by a change in the price level, AND NOTHING ELSE. It is really important that you grasp this early on, as it is so important for understanding the later topics in the course.

A shift in the AD curve is when the curve moves inwards or outwards to form a new one. This is cause by any other variable, JUST NOT A CHANGE IN THE GENERAL PRICE LEVEL.

To help revise this, click the button for my condensed flashcards!

EXAM TIP: You MUST do A LOT of practice learning about the influences on AD, and how this will change the graph. It underpins so much of the understanding for theme 2, and it can come up in any part of the exam (INCLUDING AS A 25 MARKER!!!)

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