Answer:
Aggregate means ‘total’ and in this case we use the term to measure how much is being spent by all consumers, businesses, the government and people and firms overseas.
Aggregate demand (AD) = total. spending on goods and services
The formula for calculating aggregate demand is as follows:
AD = C + I + G + (X-M)
The components of aggregate demand (AD)
C: Consumers' expenditure on goods and services: Also known as consumption, this includes demand for durables e.g. audio-visual equipment and vehicles & non-durable goods such as food and drinks which are “consumed” and must be re-purchased.
I: Capital Investment – This is spending on capital goods such as plant and equipment and new buildings to produce more consumer goods in the future. Investment includes spending on working capital such as stocks of finished and semi-finished goods.
Capital investment spending in the UK accounts for between 15-20% of GDP in any given year. Of this investment, 75% comes from private sector businesses such as Tesco, British Airways and British Petroleum and the remainder is spent by the government – for example building new schools or in improving rail or road networks. Investment has important effects on the supply-side as well as being an important component of AD.
A small part of investment spending is the change in the value of stocks. Producers may find either than demand is running higher than output (i.e. stocks will fall) or that demand is weaker than expected and below current output (in which case the value of stocks will rise.)
G: Government Spending – This is spending on state-provided goods and services including public goods and merit goods. Decisions on how much the government will spend each year are affected by developments in the economy and the political priorities of the government.
Government spending on goods and services is around 18-20% of GDP but this tends to understate the true size of the government sector in the economy. Firstly some spending is on investment and a sizeable amount goes on welfare state payments.
Transfer payments in the form of benefits (e.g. state pensions and the job-seekers allowance) are not included in current government spending because they are a transfer from one group (i.e. people paying income taxes) to another (i.e. pensioners drawing their state pension having retired, or families on low incomes).
