Question

(a) In a simple model with no government, taxes, or trade, how is aggregate demand defined? (b) Briefly explain the concept of the multiplier with respect to aggregate demand.

Answer 1

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Question:

Answer:

a). Answer:

Aggregate Demand:

The aggregate demand represents the total quantity of all goods and services demanded by the economy at different price levels. Normally there are four components of Aggregate Demand (AD); Consumption (C), Investment (I), Government Spending (G) and Net Exports (X-M). Practically the contribution of all these factors are different. The major contributor is consumption and least contributor is net Exports. The contributions are following as- Household consumption is the largest component at 61%, Government spending is 23%, Investment 15%, Net exports – 1% (current account deficit).

Technically speaking, aggregate demand only equals GDP in the long run after adjusting for the price level. This is because short-run aggregate demand measures total output for a single nominal price level whereby nominal is not adjusted for inflation. Other variations in calculations can occur depending on the methodologies used and the various components.

Aggregate demand consists of all consumer goods, capital goods (factories and equipment), exports, imports, and government spending programs. The variables are all considered equal as long as they trade at the same market value. Aggregate demand is an economic measure of the total amount of demand for all finished goods and services produced in an economy.

Now if we exclude the two factors - Government, taxes or trade we can define the aggregate demand as- AD is an economic measure of the total the amount of demand by the Consumer spending on goods and services and private investment and corporate spending on non-final capital goods (factories, equipment, etc.) .

b). Answer:

In economics, a multiplier broadly refers to an economic factor that, when increased or changed, causes increases or changes in many other related economic variables. In terms of gross domestic product, the multiplier effect causes gains in total output to be greater than the change in spending that caused it.

I have explained above that The aggregate demand represents the total quantity of all goods and services demanded by the economy at different price levels. Normally there are four components of Aggregate Demand (AD); Consumption (C), Investment (I), Government Spending (G) and Net Exports (X-M). Practically the contribution of all these factors are different.

1). Consumption: Here consumption means spending on goods and services. When government follow the expansionary monetary and fiscal policy then money supply increased and loan become less costly. so, low cost loan encourage to the consumer for more spending and because of more spending on goods and services consumption is increased and vice-versa.

2). Investment: Here investment means Private investment and corporate spending on non-final capital goods (factories, equipment, etc.).When government follow the expansionary monetary and fiscal policy then money supply increased and loan become less costly. so, low cost loan encourage to the private investment and corporate spending on non-final capital goods (factories, equipment, etc.) and consumer for more spending also. Because of more spending on non-final capital goods (factories, equipment, etc.) Its increase the productivity and efficiency of the producers and now they can produce it at low cost and sell at low price and lower the price of goods and services encourage the consumers for consuming more and its increased the AD and vice-versa.

3). Government Spending : Government spending also positively affect the income level of the consumer so, its increase the AD.

4). Net Export: Positive net export means export is higher than import. It means country is less depend upon the import so its not need to worry about the tariff and quota, subsidies and other stuff. He is able to produce the goods and services within the country at low cos( low price level). Higher the export level also appreciate the value of the domestic currency. So, all this factors increased the AD and vice-versa.

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