Question

1. State at least 2 determinants of each of the components of the AD, namely consumption, investment and net exports.
2. Explain briefly how a change in the determinants stated above may change the AD.

Answer 1

AD (aggregate demand) mainly consists of the following components:

1. Consumption

2. Investment

3. New Exports

So, it can be written as,

AD = C + I + NX (without government intervention)

where NX = X - M X = exports and M = Imports

Determinants of Consumption may include income level, future expectations about the income, interest rates, education level etc.

Determinants of Investment may include interest rates in the market, savings, investor's confidence, business confidence etc.

Determinants of Net Exports may include domestic and foreign income, technology, exchange rate (appreciation or depreciation) etc

how a change in the determinants may change the AD:

For Consumption:

A higher income level increases the consumption spending of the household and their purchasing power. As a result, people will demand more goods and services. Hence, the AD curve will shift to the right.

However, a fall in the income level has the opposite effect and shifts the AD curve to the left.

For Investment:

Higher business confidence or a lower interest rates boosts investment in the economy and shifts the AD curve to the right. However, low business confidence and higher interest rates have the opposite effect on AD curve.

For Net Exports;

Currency appreciation increases imports and decreases exports. A decline in the exports means a fall in the domestic income of the country. As a result, the AD curve will shift to left.

Depreciation increases exports and shifts the AD curve to the right.

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