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7/31/2019 Gdp in Banking 1
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AGGREGATE DEMAND AND AGGREGATE SUPPLY
Session-4
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AGGREGATE DEMAND
Defined:
o Amounts of Real Output
o Buyers Collectively Desire
o At Each Possible Price Level
Is the total level of demand for desired goods and services (at any time by all
groups within a national economy) that makes up the gross domestic
product (GDP).
It is a sum of consumption expenditure, investment expenditure,
government expenditure and net exports.
Other things equal, the amount consumers are willing to buy at a given price
level
Total demand for goods and services for a given price level
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COMPONENTSOF AGGREGATE DEMAND
Consumption Demand (Consumption of goods and services by the private
sector- C )
Investment Demand (Investment by the private sector-I )
Government expenditure (C and I by Government - G)
Net Exports ( C and I by external sector (X) minus Imports (M)
Y = C+ I + G + XM
Aggregate Demand = Actual GDP
It is the aggregate spending by the private sector, Govt. sector and net
external sector on consumption and investment goods and services in the
economy
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Aggregate Demand thus made of
o Private Sector spending
o Government sector spending
o External sector spending
This spending happens on
o Consumption of Goods and Services
o Investment in Goods and Services
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DETERMINANTS OF AGGREGATE DEMAND
Change in Consumer Spending
o Consumer Wealth
o Consumer Expectationso Consumer Indebtedness
o Taxes
Change in Investment Spending
o Real Interest Rates
o Expected Returns
Expected Future Business Conditions
Technology
Degree of Excess Capacity
Business Taxes
Government Spending
Net Export Spending
o National Income Abroad
o Exchange Rates
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MARGINAL PROPENSITYTO CONSUME (MPC)
Change in consumption expenditure in response to change in disposable
income
DISPOSABLE INCOME:
Divided into
o Consumption
o Savings
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AGGREGATE CONSUMPTION EXPENDITURE
Desire to have a smooth consumption throughout our lifetime
Lifetime consumption path depends on lifetime income
o Income we receive from our work
o Income we expect to receive from our wealth
Distinction between Permanent and Transitory Income
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People try to maintain highest smooth consumption path they can get
Derived from peoples expectations about permanent lifetime income both
from work and wealth
Current and past income from wealth and work play an important role in
peoples expectations about lifetime income.
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COMPONENTSOFCONSUMPTION
Non-durable goods likes of food, drink, cloth, lighting, heating,
entertainment, etc.( Consumable goods )
Durable goods likes of furniture, appliances, cars, scooters, air-conditioners,
jewellery, etc
Services all non-durable consisting of hair cut, laundry, transport, banking,
insurance, health, education, legal and other services
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DETERMINANTSOFCONSUMPTION
Income
Wealth
Relative income
Interest rate
Credit availability
Consumers expectations Income/wealth distribution
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FLUCTUATIONSIN CONSUMPTIONDEMAND
Due to
Changes in real disposable income
Changes in personal tax rates
Changes in Interest rates
Erosion of wealth due to unexpected happenings.
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INVESTMENT DEMAND
Investment means expenditure of funds on building new and fresh capital
goods. Aggregate Investment Expenditure is for purchase of new assets which will
help in production of future goods and services.
o Purchase new machinery
o Expenditure on setting up of new plant
Investment for the economy means spending on
physical capital, not financial capital(Equity and Debts)
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CAPITAL STOCK
Rupee value of new plants, capital equipment, machinery etc. at a
given point of time.
Investment is the change in capital stock over a period of time
Investment is a flow while capital is a stock
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IMPORTANCEOFINVESTMENTDEMAND
Investment expenditure has a dual role
Like consumption expenditure, it creates new demand, leading to anincrease in the Agg. Demand
Investments adds to the productive capacity, thereby enhancing the Agg.
Supply
Subject to wider fluctuations and hence more volatile than consumption
demand.
Affects production capacity and thus the long term growth potential of
the economy.
Investments positively affects both AD and AS
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COMPONENTSOF INVESTMENTS
Fixed non-residential(business) investments
Fixed Residential Investments
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DETERMINANTSOF AGGREGATE INVESTMENT EXPENDITURE
Outputdesired net investment is governed
positively by the change in expected output
Interest rate more investments so long as return
from the investment exceeds cost
Wage rateinvestment depends on the wage rate
Tax laws
Financing constraints
Technology
Business confidence/stock market behaviour
Government/other factors
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An economy can have different forms of savings of which household
financial savings generally constitute the largest share in aggregatedomestic savings.
Other forms of savings comprise physical savings by households, savings
by the private corporate sector and the public sector and foreign savings
Sometimes when savings exceed investment there would be deficiency of
aggregate demand and general unemployment.
Gap between S and I could be filled by government intervention either
directly by increasing government expenditure or indirectly by actions
influencing the supply of money