AGREGATE DEMAND AND RELATED CONCEPT

Aggregatedemand (AD)or Aggregate expenditure refers to the total value of

final
goods and services which all the sectors of an economy are planning to
buy at given level of
income during aperiodof one accounting year.
Aggregate expenditure refers tothe planned expenditure not the actual
Actual Expenditure can be more or less than the planned expenditure.
In Micro economics we read the term
expenditure.
market demand which means the demand of a
particular commodity in the market.
Whereas, Aggregate demand refers to the planned demand of all the final
goods
and services in an accounting year.

Whenever we spend our money on any particular commodity it adds up in

demand. aggregate
Components of Aggregate demand
Aggregate demand consists of4 elements:
1. Private(household) final consumption
expenditure (C):
It refers to the total expenditure incurred by the
household on purchase of goods and
services during an accounting year.
Example:- expenditure on purchase of tea,sugar, oil etc.
2. Investmentexpenditure([):
Itrefers to the total expenditure incurred by the private firms on capital
goods during
an accounting year.
Example:- Cxpenditure on purchase of machinery, car or any other asset.
3. Government texpenditure(G):-
Itreferstothetotal expenditure incurred by government on consumer
nerorcapitalgoodsto
satisfy
theneeds ofan economy. Investment
Consumption expenditureby govermment:--expenditure on education,,Powerplantsetc.
transportetc.
Penditureby government-expenditure on construction
 4. Net exports(X-M):
(Exports-Imports) produced withinthe domestic
Exportrefers to the
demand for goods territory of,
theworld.
countrybytherest of residents of a country for the goods
Import refers to the
demand of the producei
abroad. Aggregate Demand-C+I+G+(X-M)
demand which is the
But in the present class we just
had to learn aggregate addition o!
consumption and investment expenditure.
Aggregate Demand=C+I

shallstart our study of Aggregate Demand by taking a schedule.

Now, we
Consumption(C) Investment() Aggregate Demand(C+)
Income()
40 40 80
120 40 160
100
200 40 240
200
300 280 40 320
400 360 40 400

AD
(C+l)

Income X

Explanation:
AD=C+I
Positive Consumption even when income-0,
Aspeople needs certain basic commodities tosustain themselves even when income-0
Example:- food, water etc.
It is known as autonomous consumption
 je. Consumption when income=0
In the given diagram, OS represents autonomous consumption.
Slope of consumptioncurve:
Consumption curve slopes upward as when income increases consumption also
1ncreases

However, proportionate increase in consumption is less than that of income.

As after reaching a certain levellofincome consumer startsaving.
Slope ofInvestment curve:
the level
Investment curve slopes parallel to x-axis as it is assumed to be independent to
of income.
AD curve starts from "T, as when income-0(AD=C+I)
Aggregate Supply:
refers to the money value of goods and services that all the producers are willing to
It
supply in an economy in the given time period.
actual value could be more or less than
As Aggregate demand it is also an expected value,
the expected value.
Aggregate Supply(AS)=National Income
Y4
Components ofAggregate Supply(AS) or Income(Y): Supply
Aggregate
The income of aconsumer can be consumed or saved
So, Aggregate supply comprises of2 components: B

1. Consumption(C) 45° B
X
2. Saving(S)
SDissaving
OR AS=C+S
Y= ASE C+S Income ’

Saving(S) Aggregate Supply(AS)

Income(Y) Consumption(C)
-40 0
40
-20 100
100 120
0 200
200 200
300
300 280 40
400
400 360 40
 Explanation:
AS=C+S
Positive consumption even when income=0(
Slope ofConsumption curve:
Consumption curve slopes upward as when income increases co
consumption
also increases.
Slope of Saving Curve:
COnSuin
The Saving curve also slopes upwar.
Break-even point(B):
Saving=0which means the whole income is being consumed
i.e.Consumption=Income
Before Break-even point, Saving is negative which
means economy
dissaving(C>I)
The AS curve slopes upward at 45°
AsAggregate supply is always equal to income.
Dissaving:- It refers to a situation where saving is negative. It means that
economy isnot saving but also taking out the past saving as the
consumption>Income.
Consumption Function(Propensity to consume):
It refers to the functional relationship between consumption and
C-f(Y) National income.

C= Consumption
C=f(Y)
Y=National Income
f- functional relationship
It represents the willingness
levelofincome during agiven time ofhouseholds to purchase goods and services at the
given
It shows the consumption level at period.
different level of income.
It is apsychological concept as it is
influenced by subjective factors such as consumer
preferences, habits etc.

Types of Propensity to consume:

1. Average Propensity to Consume(APC)
2. Marginal Propensity to Consume(MPC)
 1. Average Propensity to Consume(APC):
Itrefers to the ratio of consumptionexpenditure to the corresponding level ofincome
In other words, it shows how much income is consumed by the consumer.

aome(Y) Consumption(C) APC= CY

0 40
120 1.206)
100 APC= Consumption (C)
200
200 200
100 Income ()
300 280 0,93300
400 360 0.90(60)
400

. Observations:
APC>1, when Income is less than Consumption(before break-even point)
APC=l,when Income is equal to Consumption(at break-even point)
APC<1,when Income is greater than consumption(beyond break-even point)
APCfalls as income increases.
APC0
As Consumption 0even when Income-0(autonomous consumption)

1. Marginal Propensity to Consume(MPC):

Itrefers to the ratio of changein consumption and change in total income.
In other words, it shows the amount ofadditional income consumed by the consumer.
MPC=.Change in consumption (AC)
Change in Income(AY)

Income(Y) Consumption(C) AC AY MPC=

AY
0 40

100 120 80 100 0.80()

100
80
200 200 80 100
0.80 100
80
300 280 80 100 0.80(-100
80
400 360 80 100
0.80(,00
 About MPC;
0<MPCKI income is saved and
additional change ing
MPC=0, whenentire additional inc

changeCOnsinumpconnsu
when entire income is consumed and
MPC=1,
to thechange in income.
equal
MPCofpoor>MPCofrich
consume, whereas a rich earn:and saves a
Asa poor earnand part
of ther ingK
MPC of developing country>MPCof developedcolunt
Similarly,

Saving Function(Propensity to Save): c.

It refers to the functional relationship between saving andNational income
S=f (Y)
S=Saving Y=National Income
f functional relationship
Itrepresents the willingness ofhouseholds to saves a part of their income.
" Propensity to save represents the different level of saving at different levelofin:
" It is a psychological concept as it is influenced by the subjective factors ot t
sets of consumers.

. Types of Propensity to Save:

1. Average Propensity to Save.
2. Marginal Propensity to Save.

1.
Average Propensity to Save(APS):
ltrefers to the ratio of saving to the corresponding level of
In other income
words, it shows that how much income is saved by
the consu

APS= Saving (S)

Income (Y)
 Income(Y) Consumption(C) Saving(S) |APS= Saving (S)
Income (Y)
40 -40

100 120 -20 -0.20(20

100
80
200 200 0 0 200
20
300 280 20 0.06() 300
40
400 360 40 0.1()
400

Observations:
APS can always be less than 1(as a consumer can't save whole or more of
what he had earned)
APS can be Negative(before break-even point) (Dissaving)
APS can be 0 (at break-even Point)
APS increases when Income increases.
1. Marginal Propensity to Save(MPS):
It refers to the ratio of change in saving to the change in total income. In other
words, it represents the willingness ofa consumer to save from his additional income.

MPS=
Change in Saving (AS)
Change in Income (AY)

Saving( AS)
Income(Y) Consumption(C) Saving(S) AS AY MPS= Income(A Y
40 -40 20 100
0.20,20
100
20
100 120 -20 20 100 0.20(-100
20
200 200 0 20 100 0.20( 100
20
300 280 20 20 100 0.20()
100
20
400 360 40 20 100 0.20( 100
 Observations:
0<MPS<1
MPS-0, if entire additional income is consunmed.
MPS=1, if entire additional income is saved.
APC+APS=1(entire income is either consumed or saved)
MPC+MPS=1(entire additional income is either consumed or saved)
Linear Consumption function:
In order to calculate the level of consumption at any level of income we just need fo
basic things which are as follows:

C(Autonomus Consumption)
Level ofncome at which consumption is to be calculated.
MPC(Marginal propensity to consume)
Consumption= Ctb(Y)
AC
C=Autonomus Consumption b= MPC=
Y= level of income on which
consumption is to calculated
Linear Saving Function:
In order tocalculate the level of saving at
any given level of income we require some basI
things which are as followS:

C(Autonomus Consumption)
Level of Income at which consumption is to be
calculated.
MPS(Marginal propensity to Save)
Saving= C+(1-b)(Y)
C=Autonomus Consumption (1-b)=1-MPC-MPS ( )
Y= level of income on which consumption is to calculate

Example:
From the giventable, calculate consumption and saving when the income is
rupees 2000
Income(Y) Consumption(C) Saving(S) AC AS AY MPC-ACMPC_AS
AY AY
80
40 -40 80 100 20 0.80( 100 0.20()
100
80 20

100
120 -20 80 100 20 0.80(100 0.20)100
80
200 0 80 100 20 0.80(-)
100
0.20(
100
200
80
0.20(20
300 280 20 80 100 20
0.80,00 100

360 40 80 100 20
80
0.80(,) 0.20(2
100
400

Here, C=40
MPC(b)=0.80
MPS(1-b)-0.20
Levelof income-2000

Consumption= C+ b(Y) Saving= - C+(1-b)(Y)

-40+0.80(2000) = 40+0.20(2000)
=40+1600
=40+400

Consumption=1640 Saving= 360

Consumption and Saving functions are A.S

complementary:- Since,
(Y=C+S
Income X
DOth Consumption and Saving curve are
to each other as they together make
complementary
upthe income. A.S
Ther efore, fthem is known then other can be
if one ofthemi
easily obtained (S=0)

Dis-saving
S=Y-C and C=Y-S Income
Investment Function:
Investment refers to the expenditure incurred on creation ofnew assets
Example:- Investment on building, Machinery etc.
Basically investments are of2 types:
1. Autonomous Investment
2. Induced Investment

1. Autonomus Investment:
It refers to the investmentwhich is not affected by the Investment

change in level of income and is not induced for profit

motive. It is the basic and necessary investment which
snot guided for profit motive. This isgenerally made
by the government on infrastructural activities. It is
income inelastic.( investment remains constant even
when income increases)
Y -
Income

YA

Investment
2. Induced Investment:
It refers to the investment which depends upon the M'
profit expectations. M

It is directly influenced by the income level.

ie. ifincome increases then
investment also increases Y
Income

Determinants of Investment:
Every individual invest in order to gain some
The decision to invest in a new expected rate of return
project mainly depends upon 2 factors
Marginal efficiency of investment(MEI)
2. Rate of
Interest(ROI)
1. Marginal efficiency of investment(MEI);
It refers to the eXpected rate of return fron the project in which we are aboutto
invest.
This could be the
expected reward of the
. Rate of interest((RO):
It refers to the cost of borrowing money from financial market.

Investment is treated to be aa profitable one only if:-

MEI>ROI

Ex-ante saving and investment

(Planned or desired saving and investment)

Ex-post saving and investment

(Actual or realized saving and investment)

Important terms:
1. Full employment:
It refers toa situation in which all those who are willing and able to word get work
without any undue difficulty.
Under full employment there can be 2 types of unemployment;
Fictional unemployment(temporary unemployment):
(Exist during the period when workers leave one job and join the other)
Structural unemployment:
Itrefers to the unemployment in which people remains unemployed due to
mismatch between unemployed persons and the demand for specific type of
workers
2. Involuntary unemployment:
t refers to acondition of unemployment in which allthose whoare
willingand
dble to work at the existing wage rate doesn't get work.
3. Voluntary unemployment:-
because
Tefers to a condition of unemployment in which persons are unemployed
they are not willing to work at the existing wage rate.