In the previous section, we saw the formula for aggregate demand (AD) is:
$$ \text{AD} = C + I + G + (X - M) $$
This section will break down each component.
Consumer spending (C)
Consumption (C) represents all spending made by households on finalgoods and services during a particular time period.
Tip
Remember, consumption is driven by disposable income: the money households have available to spend (after paying taxes, outside saving accounts...).
Investment (I)
The investment (I) component of AD is composed of investments:
By firms on physical capital: money spent on assets used to produce goods and services (factories, machinery, offices...).
By households and firms on new construction: new housing and other new construction assets.
Note
Investment is more volatile than consumption because it depends heavily on expectations about the future.
Government Spending (G)
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What is Aggregate Demand (AD)?
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Note
Introduction to Aggregate Demand
Aggregate Demand (AD) represents the total planned spending on an economy's goods and services at a given price level and time period.
The formula for AD is: AD=C+I+G+(X−M)
Where each letter represents a different type of spending:
C = Consumption
I = Investment
G = Government spending
(X−M) = Net exports
Definition
Aggregate Demand (AD)
The total planned spending on an economy's goods and services at a given price level and time period.
Analogy
Think of aggregate demand like a pie, with each component (C, I, G, X-M) representing a different slice. The size of each slice shows how much each group contributes to the total spending in the economy.
Example
In 2020, the United States had an aggregate demand of approximately €21 trillion, with consumption making up about 68% of the total.
