The national economy is extremely mobile and feels the impact of changes in capital, labor and scientific and technological progress. But sometimes firms cannot sell the entire volume of output, which leads to a slowdown in production and a decrease in GDP. This can be explained by the economic model of aggregate supply and demand. This model answers the questions of why prices fluctuate, what determines the actual national production, why its changes are spasmodic, etc. To simplify the analysis of processes in the national economy, the concepts of aggregate supply and aggregate demand, as well as the global price level, are introduced.
What is demand?
The concept of “aggregate demand” summarizes in itself all the final goods of the national economy for which there is a demand in the country's markets under certain conditions in a certain time period. In terms of meaning, this concept is similar to gross national product. Its value can be determined using the Fisher formula:
M * V = P * Q,
Where:
- M is the total money supply;
- V is the speed of turnover of funds;
- P is the average level of commodity prices;
- Q - the total mass of goods in the markets of the country.
But at the same time, there are differences between these categories:
- GNP is determined for the year, aggregate demand - for any period of time.
- GNP includes, along with goods and services, while demand contains real products.
- GNP is the result of the activities of companies in this state. And subjects of aggregate demand include:
- the country's population - demand for consumer goods (C);
- companies - demand for investments (I);
- the state through the public procurement system (G);
- net exports - state exports minus imports (Xn).
The formula for calculating aggregate demand (AD) will look like:
AD = C + I + G + e.
What does the demand curve show?
Also, using the graph, you can display aggregate demand. The demand curve (AD) along the ordinate axis shows the price level (P), and along the abscissa axis the real (in the prices of the base period) product.
This diagram illustrates the fluctuations in government spending, companies, people and foreign countries, which are caused by changes in the price level. The aggregate demand curve shows a tendency to decrease in demand for goods as prices increase. Moreover, this decrease affects absolutely all spheres of economic life: investment, consumption, export (net) and government spending.
Price factors of influence on demand
Analyzing the graph of the AD curve, you can notice its falling character, which is explained by the following effects:
- Interest rate. Under constant conditions, the higher its rate, the lower the volume of aggregate demand. The great importance of this indicator reduces borrowing and, accordingly, purchases. A change in the demand curve from a low rate is the opposite, and the economy is stimulated.
- Import purchases (national currency exchange rate). A decrease in the relative value of the national currency leads to a reduction in the cost of goods produced in the country. Thus, their competitiveness in world markets increases, exports increase, and therefore, aggregate demand also grows. The demand curve changes slope.
- Real wealth. A rise in prices leads to a decrease in the intrinsic value of money in both paper and accumulated equivalent forms. The fall in prices, on the contrary, increases purchasing power, and people, in fact having the same amount, feel richer, and demand is growing.
The combination of these incentives leads to the fact that the slope of the demand curve is negative. These factors are price, and their influence is considered subject to the constancy of the money supply in the national economy.
Non-price impact
The shift in the demand curve has the following form and can be caused by factors that influence the change in expenditures of the population, business, and the state.
Consumption expenses
- The level of consumer welfare. The decrease in the actual value of money and their equivalents stimulates the process of saving. As a result, there is a decrease in purchasing activity of the population and a shift of the curve to the left (and vice versa).
- Consumer forecasts and expectations. If a consumer expects an increase in income in the future, he will spend more today (and vice versa).
- "Credit history" of consumers. The high debt from previous purchases on credit forces us to buy less today and save money on paying off an existing loan. The market demand curve will again shift to the left.
- State taxes. Reducing the tax rate on income entails an increase in the standard of living of the population and increases its purchasing power at a constant price level.
Investment expenses
- Interest rate. Provided all macroeconomic conditions, including the price level, remain unchanged, any increase will force investment costs to be reduced, and this will necessarily lead to a decrease in demand. The demand curve will again shift to the left.
- Expected return on investment. A favorable investment climate and good forecasts for future accumulated profits will certainly increase the demand for infusion of funds. The schedule will behave accordingly. The demand curve will shift to the right.
- Tax pressure. The larger it is, the lower the profit of economic entities, which is a strong incentive to reduce investment costs and demand in general.
- The growth of excess capacity. A company that does not work at full strength will not think about any extensions. If the capacities are reduced, there will be an incentive to expand territories, open new branches and so on. Thus, an increase in this indicator reduces the need for an investment product, therefore, aggregate demand will also decrease. The demand curve will shift to the left.
Government spending
Provided prices, interest rates and tax deductions remain constant, an increase in public procurement will lead to an increase in aggregate demand. That is, the ratio between these economic categories is directly proportional.
Export costs
Their growth leads to a shift of the graph to the right, a decrease - to the left. It is logical that a decrease in the influx of imported goods increases domestic demand for domestic products. The aggregate demand curve also shifts under the influence of the following export-related indicators:
- Income of national economies of other countries. The greater the income of the importing countries, the more of our goods they will buy. This will increase the net export rate of our state and increase aggregate demand.
- Currency Rates. A decrease in the national currency exchange rate in relation to the monetary unit of another country leads to a decrease in domestic demand for imports and an increase in exports to this state. Consequently, net exports and aggregate demand will increase. This process, of course, will have an impact on the schedule. The demand curve will shift to the right.
Mutual integration of national economies is quite large. That is why a change in these macroeconomic indicators is reflected in many interacting systems.
The impact of savings
The demand curve is a graphical representation of the economic trends of the national economy. Another important factor influencing its displacement is the marginal propensity to save, an indicator of the distribution of income on consumption and on savings.
As a conclusion, it should be added that the demand curve shows, with its shift to the right or left, the nature of the influence of non-price factors on the total value.
What is an aggregate offer?
The concept of aggregate supply summarizes all the final goods offered in the country's markets for a certain period of time under constant conditions. This indicator may be equal to GNP, since it represents the entire volume of real production.
In macroeconomics, the schedule of aggregate supply depending on the level of employment (incomplete, approaching full and full) has three sections:
- Keynesian Range (horizontal).
- Intermediate Range (up).
- Classical Range (vertical).
Three offer segments
The Keynesian Range of the supply curve remains horizontal at a certain price level, meaning that firms provide any volume of production at that level.
The classic component of the graphics (Intermediate Range) is always vertical. It means the constancy of the volume of output of goods at a certain price range.
The Classical Range characterizes the gradual involvement of free production factors to certain boundaries. Their further involvement will ultimately increase costs, and therefore prices. The cost of services and goods is gradually increasing against the background of not so rapid production growth.
Non-price impact
All factors of a non-price nature that have an impact on the level of consumption are divided into:
1. Fluctuations in resource prices:
- internal - with an increase in the number of internal resources, the supply curve moves to the right;
- import prices - their reduction will increase the aggregate supply (and vice versa).
2. Changes in the rule of law:
- Taxation and subsidies. An increase in tax pressure raises production costs, reducing, respectively, the aggregate supply. Subsidies, by contrast, help with financial investments in the business and lead to lower costs and higher supply.
- State regulation. Excessive government control increases production costs and shifts the supply curve to the left.
conclusions
To study short-term macroeconomic fluctuations, a model of aggregate supply and demand is used. The main postulate of this theory is that the level of production of consumer goods, as well as their prices, are changed in such a way as to balance the total supply and demand.
Under such conditions, the demand graph will have a negative slope. This provokes the following processes:
- Lower prices cause an increase in the real value of household financial assets, which is a factor in stimulating consumption.
- Low prices reduce the demand for money, increasing investment costs.
- Lowering the price level provokes a decrease in interest rates. The consequence of this is the depreciation of the state currency and the stimulation of net exports.
The aggregate supply curve in the long run is vertical. This is because the number of services and goods offered depends on labor, technology and capital in the economy, and not on the general price level. The short-term curve has a positive slope.
The study of the system of “aggregate demand - aggregate consumption” is of great importance for understanding macroeconomic processes. However, many schools are contradictory about the same facts, and with a difference in the interpretation of the same phenomena, it can be difficult to reach a general conclusion. The type of economic policy and the consequences caused by it directly depend on the goals and motives of people who have a direct impact on the course of economic and social processes.