aggregate demand
TRANSCRIPT
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The Concept of Aggregate
Demand In India
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What is Aggregate Demand
Aggregate demand refers to the total amount that different sectors in the economy are willing to spend in a given period.
It is the sum spending by consumers, businessmen, Government and other agencies in the country i.e. It measures the total spending by all different entities in the economy.
It depends upon:Level of pricesMonetary policyFiscal policyOther factors
Source: Introductory Economic Theory XII – 7th edition
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Determinants of aggregate demand
AD = C + I + G + (X-M)Where; AD = Aggregate demand
C = Consumption
I = Investment
G = Government
demand
(X-M) = (Export – Import) i.e. Net
income from foreign
transactionsSource: Introductory Economic Theory XII – 7th edition
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A. Consumption (C)The amount which consumers are willing to spend on the purchase of goods and services for satisfaction of their wants
Those goods & services which are utilized for final satisfaction of human wants E.g. TV, car, rice, milk
Consumption depends on the following factors:
Level of household income Credit facilitiesOutlook for futureDisposable incomeStock of wealthAdvertisementAvailability of goods & servicesCultural attitudeAverage size and composition of householdsSource: Introductory Economic Theory XII – 7th edition
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B. Investment DemandThe use of saving for the purpose of production made by an individual or a business firm.
Aim: acquire capital goods or assets E.g. Machinery plant, factory buildings etc.
Investment expenditure also made by Govt. To increase stock of Social and economic overheads
Types:
Private investment
Public investment
Foreign investment
Gross investment
Net investment
Induced investment
Autonomous
investment
Source: Introductory Economic Theory XII – 7th edition
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B. Investment Demand
DETERMINANTS
Level of saving
Rate of interest
Marginal efficiency of capital
Supply of money
and bank credit
Innovation and
technology advance
Stock of fixed
capital
Expectation about future
changes
Source: Introductory Economic Theory XII – 7th edition
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C. Government Demand
Government Expenditure
Consumption Expenditure by
Govt.
Investment expenditure by
Govt.
When these expenditures are incurred by the Govt, it increases aggregate demand. When the Govt makes payment for goods and services purchased and when the amount received by factors of production is used by factors for purchase of goods & services produced in the country, it increases the demand for goods & services.Source: Introductory Economic Theory XII – 7th edition
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D. Foreign Demand (X-M)
Export: Selling of goods & services – capital & consumer goods by one country to different countries of the world
Import: Purchase of goods & services – capital & consumer goods by a country from different countries in the world. Increases agg. demand
Net earnings from foreign transaction: Export – Import This can be positive, negative or even zero
Source: Introductory Economic Theory XII – 7th edition
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Consumption goods & services by the private sector (C)
Consumption & Investment goods and services by Government (G)
Consumption & investment goods and services by foreigners (X)
Private Sector Demand
Public Sector Demand
Net External Sector Demand
+ + +
Total Spending On
-All Imports(M)
Aggregate Demand = C + I + G + (X – M)
Investment goods and services by the private sector (I)
Components of aggregate demand
10Source: indiabudget.nic.in/es2009-10/chapt2010/chapter01.pdf
Change in Aggregate Demand over the years
Source: indiabudget.nic.in/es2009-10/chapt2010/chapter01.pdf
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Causes of changes in Aggregate Demand
Changes in the monetary policy Fluctuations in the exchange
rate Consumer confidence Changes in the economic conditions of other
countries Fiscal policy Taxes and aggregate demand
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Demand side shocks Capital investment boom Rise or fall in the exchange rate Consumer boom abroad in the country of one of our
major trading partners
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Computation of aggregate demand
Formula: Aggregate Demand (AD) = C + I + G + (X-M)
Example
For the year 2007- 2008 C = Rs 30 cores I = Rs 44 cores G = Rs 20 cores (X-M) = Rs -3 cores
Aggregate demand = 30 +44 + 20 +( - 3)Aggregate demand = Rs 91 coresGDP = 9.1 %
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ExplanationTill 2006-07 the most contributing
component in aggregate demand was investments
In 2007-08 along with investments the consumer expenditure was also higher than previous years
The external trade made negligible or negative contribution.
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Difference between GDP and AD
Aggregate demand curve explains the level of goods demanded at each price level
GDP is actual level of goods exchanged
One is the curve, the other is the actual point of intersection
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Downward Sloping Demand Curve
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Main Reasons behind the downward sloping demand curve
The Price Level and Consumption: The Wealth Effect
The Price Level and Investment: The Interest Rate Effect
The Price Level and Net Exports: The Exchange - Rate Effect
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The Wealth Effect
• A decrease in the price level makes consumers feel more wealthy, which in turn encourages them to spend more
• This increase in consumer spending means larger quantities of goods and services demanded
The Interest Rate Effect
• A lower price level reduces the interest rate, which encourages greater spending on investment goods
• This increase in investment spending means a larger quantity of goods and services demanded
The Exchange-Rate Effect
• When a fall in the price level causes INDIA’s interest rates to fall, the real exchange rate depreciates, which stimulates U.S. net exports
• The increase in net export spending means a larger quantity of goods and services demanded
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Shifts in Aggregate Demand Curve &
factors causing the shift
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Shift in Aggregate Demand Curve
RightLeft
AD1 AD2AD3
Price Level
Real GDP
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Shift Arising from Consumption
Exogenous factors affecting consumption◦ Tax rates◦ Incomes – short term and expected
income over lifetime◦ Wage increases◦ Wealth
Property Shares Savings Bonds
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Shift Arising from Investment Spending on:
◦ Machinery◦ Equipment◦ Buildings◦ Infrastructure
Influenced by:◦ Expected rates of
return◦ Interest rates◦ Expectations of
future sales
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Shift Arising from Government PurchaseDefenceHealthSocial WelfareEducationForeign AidRegionsIndustryLaw and Order
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Shift Arising from Net exports
RecessionMovements in
the exchange Rate
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Contractionary monetary policyMs AD curve shifts to the left
Contractionary fiscal policyG AD curve shifts to the left
T AD curve shifts to the left
Expansionary monetary policyMs AD curve shifts to the right
Expansionary fiscal policyG AD curve shifts to the right
T AD curve shifts to the right
Shifts in the Aggregate Demand Curve: A Summary
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Demand Scenario in the Indian Economy
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Positive Features
Negative Features
Higher Growth
Change in Life style
Demographic Changes
Growing Regional Inequality
Uneven Sectoral Growth
Signals Current Demand
Signal Potential Demand/Problems
Recent trends in the Indian economy
Source: Macro-economic policy environment ; Shyamal Roy
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India: Sectoral share of GDP, 1990-91 to 2005-06
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
1990-91
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
Perc
enta
ge o
f GD
P
Services share Industry Share Agriculture Share
Source: Macro-economic policy environment ; Shyamal Roy
30
India: GDP Growth, 1991-92 to 2005-06
1.3
5.12
5.9
7.25 7.347.84
4.79
6.51 6.36
4.37
5.79
3.77
8.51
7.53
8.43
0
1
2
3
4
5
6
7
8
9
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
% c
hang
e pe
r ann
um
Source: Macro-economic policy environment ; Shyamal Roy
31
India: Overall and Sectoral GDP growth, 1990-91 to 2005-06
-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06%
per
ann
um
GDP Services Industry Agriculture
Source: Macro-economic policy environment ; Shyamal Roy
32
A disaggregated look , gives the following picture:•Services sector (62%) has been impressive and
largely domestic demand driven• Industry (19%), showed a sluggish growth rate but
has since revived.•Agricultural sector (19%) continues to be random,
depending on weather
Disaggregated look
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• Indian GDP growth has been largely propelled by the growth of the service sector
• The service sector growth and, thus, the overall growth is unsustainable unless the other two sectors of the economy also register a higher growth
• Sustained growth in industry and a turnaround in agriculture is constrained by lack of investment in infrastructure
• Investment in infrastructure, thus, holds the key to sustained growth of GDP in India
Analysis of growth
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Sector Share
Agriculture 19%
Industry 20%
Services 61%
All 100%
State of the Indian economy today
Source: Macro-economic policy environment ; Shyamal Roy
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Understanding the global context
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Global Economic Structure Today• US, Japan and the European region account for more than 60% of global GDP
• Substantial part of the rest of the world’s GDP growth is driven by what happens in the above countries
• India and China are different
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Global Economic Prospects•US economic is on the path of recovery however,
not without certain concerns•Europe and Japan still have some ways to go in
terms of sustained recovery•China is doing well and is substituting US, Japan,
and Europe, to some extent, in terms of providing market for other country's products
• India is the other country which is doing well and is attracting lot of business interest from abroad
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Special Cases of China and India
•Both are large economies with a large domestic market
•They are the fastest and second fastest growing economies, respectively, in the world today
•Both have a huge potential for growth•Both are attracting considerable investment interest from abroad
•Both are capable of considerably tilting the balance against excessive dependence on west, particularly, the US
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India: Problems and Prospects
• Structural rigidities, lack of infrastructural support have been the key bottlenecks
• Coalition politics dictates the pace of change
• However, no policy uncertainty• Substantial rise in investment in infrastructure which is crowding in rather than crowding out private sector investment
•Offers tremendous potential in knowledge based industries
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China: Problems and Prospects
• Financial Sector extremely fragile and highly vulnerable
• Piracy rampant• Structural rigidities•Philosophical question remains as to how long a communist government will be able to foster market driven policies in the face of growing inequalities
• However, infrastructure highly developed• Government hassles least
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What’s in store for the future ?
• Global investment interests may shift towards non- Japan Asia, including South Asia in the short run
• US and some other countries may be tempted to resort to protectionist measures
• The biggest threat to globalization and free trade may come from return of protectionism
• Hopefully, long term considerations will outweigh short term economic pressures
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Bibliography http://www.cliffsnotes.com/study_guide/Aggregate-De
mand-AD-Curve.topicArticleId-9789,articleId-9737.html
http://tutor2u.net/economics/revision-notes/as-macro-aggregate-demand.html\
http://indiabudget.nic.in/
http://indiabudget.nic.in/es2008-09/seconomy.htm
Introductory Economic Theory, 7th edition
Macroeconomic policy environment, Shyamal Roy
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