2.5: Aggregate demand as an influence on Australia's cyclical level of economic activity (PART 1)

Definition of Aggregate demand
1. macroeconomic variable
2. consists of spending by both households and businesses (C), private investment spending and equipment (I), speeding by gov (G1), investment by gov (G2) and exports (X) minus spending on imports (M).
3. AD=C+I+G1+G2+X-M
John Maynard Keynes
1. instability in Aggregate Demand causes the ups and downs of economic activity
2. came up with the idea below
The effect of cyclical changes in AD on economic activity
1. improve understanding of what determines economic activity we focus on the instability of AD and its components.
2. How rising AD causes economic activity to expand.
  1. AD grows, due to a fall in leakages, firms see growing sales,lengthening orders and a fall in unsold goods.
  2. expand their levels of production providing that resources are available
    1. most firms do this = expansion in the economy
  3. no unused productive capacity - rising AD will make a shortage of goods and services.
    1. This will cause rising prices or demand inflations. This all happens in a boom
3. How slowing AD causes economic activity to contract.
  1. AD falls, due to a rise in leakages, firms notice the falling sales, absence of orders rising stocks of unsold goods
  2. Businesses cut production to prevent overproduction.
    1. most firms do this = slow down in the level of economic activity
      1. could end in a recession or depression
  3. Slow downs will cause high levels of unemployment and possibly lower inflation because most firms cut prices to get rid of extra stocks.
4. How AD can create ‘ideal’ conditions of domestic economic stability.
  1. Ideal when the level of AD is neither excess ion or insufficient that it results in a boom or recession
  2. Economy could benefit from experiencing domestic economic stability
  3. Governments try to create policies including taxes, government spending and interest rates to try and stabilise the level of AD.
The components of AD and their demand side determinants
1. levels of aggregate demand (C,I,G1,G2 and X) respond to aggregate demand side factors.
2. Strong demand side conditions can increase AD.
  1. AD to accelerate due to rising C,I,G and X
  2. Sales rise
  3. Employ extra workers, lowering cyclical unemployment
  4. Firms raise production levels - activity rises which could lead to a boom.
3. Weak demand side conditions can decrease AD
  1. AD will slow due to C,I,G and X
  2. Sales fall
  3. unsold goods in warehouses rise - leads to price drops
  4. Firms cut their labour - high unemployment
  5. Reduction of production levels creating a downswing in the business cycle.
4. Net increase in unsold business stocks
  1. Minor item in AD
  2. Macroeconomic demand side factors including business expectations, alter level of stock.
  3. Confidence can cause unplanned changes
The components of AD and their demand side determinants
1. Private Consumption (C)
  1. household expenditure to help satisfy our unlimited needs and wants.
  2. more stable that Private Investment, I
  3. Growth in this sector is rare contributing to economic instability
  4. influenced by demand side factors including consumer confidence, disposable income, saving ratios, interest rates, tax rates and population growth.
  5. 60% of AD
2. Private Investment (I)
  1. involves private business capital spending on physical plant, manufactured materials and equipment used to make other goods and services
  2. Helps raise our nations productive capacity, make production possible and raise efficiency
    1. 22% of AD
  3. unusable and is a major cause of economic instability
  4. Responds to macroeconomic demand side factors including changes in business confidence, interest rates and company tax rates.
3. Government consumption (G1)
  1. G1 is all about government spending on public goods and services to satisfy the needs and wants of individuals
  2. Incorporates staff wages for gov departments, defence spending, day to day running costs. (NOT WELFARE)
  3. changes in response to election promises, voter reactions, population growth and the budget outcome
  4. averaged 17% of AD
4. Government investment (G2)
  1. incorporates government spending on equipment.
  2. Used to help satisfy the needs and wants of the community
  3. level changes in regards to macroeconomic demand side factors including voter expectations, election promises, population growth and availability of government revenue.
  4. 3% of AD
5. Net exports (X-M)
  1. represents balance between foreign spending on Australia’s exports minus our spending on imports.
  2. together 18-24% of AD
  3. Behaves erratically and is greatly affected by the exchange rate, overseas activity, consumer confidence, business confidence and government policies (tariffs)

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2.5: Aggregate demand as an influence on Australia's cyclical level of economic activity (PART 1)

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