Chapter 8, Problem 1TY

To determine

To describe: The four main components of aggregate demand and the largest and smallest one.

Answer to Problem 1TY

Four main components are consumption, investment, Government expenditure and net exports.

Largest component is consumption expenditure and the smallest one is net exports.

Explanation of Solution

The four main components are as follows:

Consumption: It can be stated as the spending for purchasing goods and services. It always depends positively on the disposable income and depends on the size of income and marginal propensity to consume. The consumption will be greater when the disposable income is greater.

Investment : It is to enhance the productivity by adding to the existing capital. It can be machinery, payment for additional labor, addition of stock capital, etc.

Government expenditure : This includes the purchase of goods and services by government at a point of time and is denoted by G.

Net exports: It can be defined as the difference between imports and exports. The money value will be more when exports are greater than the imports and vice versa.

The aggregate demand can be calculated by the equation.

  $AD=C+1+G+NX$

  $\begin{array}{l}where\\ AD=\text{ Aggregate demad}\\ C=\text{ Consumption expenditure}\\ G\text{ = Government expenditure}\\ NX\text{ = Net exports}\end{array}$

From the above equation, it is clear that the aggregate demand is the sum of consumption, investment, government expenditure and net exports.

The largest component is the consumption expenditure as it constitutes of two-third of the overall expenditure. While net exports is the smallest component as it is the difference between the imports and exports, the value of this difference would be smaller

Economics Concept Introduction

Introduction: Aggregate demand is an economic indicator of the overall demand for all finished goods and services produced in an economy. At a given price level and point in time, aggregate demand is defined as the cumulative amount of money traded for certain goods and services.