The need for a general model. The consequences of the forced liberalization of economic activity in Russia were reflected in the state of aggregate supply and demand: liberalization of prices and the elimination of shortages of consumer goods (including through imports) led to the redistribution of household funds in favor of current consumption at the expense of previously accumulated savings.
Structural restructuring of the economy in the process of liberalization of economic life, associated, in particular, with changes in the structure of demand and relative prices, in a certain way influenced the state of aggregate supply. For example, due to the mismatch in the structure of production factors employed in different industries, it was impossible to completely redistribute them in accordance with new needs from declining industries to promising ones. In this regard, not all of the production potential involved in the pre-perestroika period could be used after economic liberalization. Factors such as the severance of a number of production ties and the reduction of trade relations with the former Soviet republics and CMEA partners also acted to reduce the volume of potential output (long-term aggregate supply). The phenomenon of “hysteresis” - the loss of part of the production potential, due to the fact that the decline in production turned out to be quite stable and long-term, was quite clearly manifested in the transition economy of Russia. Model AD-AS(with a certain degree of conditionality) can be used to interpret and analyze the processes occurring in the transition economies of Russia and other countries.
The long-term depressed state of the economy led to a decrease in real incomes of the bulk of the population, which caused a subsequent fall in aggregate demand. The decline in investment activity in the economy also had an effect in the same direction, which reduced the investment component of aggregate demand. Graphically this is illustrated by the left shift of the curve A.D. which further intensifies the decline, at least in the short term, although it slightly reduces the price level or slows down inflation (if prices are downward inelastic) [ 1 ].
So the model AD-AS can be used both to illustrate and to assess the prospects for events in transition economies in all cases when aggregate supply and demand begin to work in accordance with the laws of the emerging market mechanism.
Aggregation- consolidation of economic indicators by combining them into a single group. Aggregate indicators represent generalized, synthetic measures that combine many private indicators in one general indicator. For example, the indicator of industrial production in a country represents the total value of production volumes of all industrial enterprises. Aggregation is carried out through summation, grouping or other methods of reducing particular indicators into generalized ones. The basis of the macroeconomics method is aggregation, which means the combination of similar economic entities and objects into the largest possible groups. For example, during aggregation, all consumers are combined into the household sector. The aggregation of objects of economic relations leads to the fact that all individual goods and means of production are transformed into a single good, acting both as an object of consumption and as a means of production.
Aggregation markets is carried out with the aim of identifying the patterns of functioning of each of them, namely: studying the peculiarities of the formation of supply and demand and the conditions of their equilibrium in each of the markets; determining the equilibrium price and equilibrium volume based on the relationship between supply and demand; analysis of the consequences of changes in equilibrium in each market.
Market aggregation makes it possible to identify four macroeconomic markets:
- 1) market for goods and services (real market);
- 2) financial market (market for financial assets);
- 3) market of economic resources;
- 4) foreign exchange market.
To obtain an aggregated market of goods and services (goods market) we must abstract from the entire variety of goods produced by the economy and highlight the most important patterns of the functioning of this market, i.e. patterns of formation of demand and supply of goods and services. The relationship between supply and demand allows us to obtain the equilibrium price level (price level) for goods and services and the equilibrium volume of their production (output). The market for goods and services is also called the real market (real market), since real assets (real values - real assets). Aggregation, in addition to combining subjects and objects into large groups, also means summing up their characteristics. For example, summing the value of all goods produced in an economy gives the gross product.
The advantage of aggregation is the maximum simplification of the subject, which allows you to detect and analyze those of its properties that cannot be noticed with a large number of elements in the analyzed system.
4.2 Aggregate demand and aggregate supply
In order to better understand the problem of macroeconomic equilibrium, consider aggregate demand and aggregate supply (AD-AS model).
Aggregate demand (AD - aggregate demand) is the sum of all types of demand, or the total demand for all final products and services produced in society. Aggregate demand reflects the relationship between the price level and the volume of output that consumers are willing to buy at a given price level. Graphically, aggregate demand is shown in Fig. 4.1.
Rice. 4.1. Aggregate demand curve
Aggregate demand includes the following main components:
Demand for consumer goods and services (C). When the price level increases, consumer demand decreases, i.e. the purchasing power of accumulated income decreases;
Demand for investment goods (I) - an increase in prices leads to an increase in the interest rate as the demand for money increases. An increase in interest rates reduces the volume of real planned investments;
Demand for goods and services from the government (G), so-called government procurement. An increase in the price level in the country reduces government purchases, since the allocation of funds from the budget for government purchases is carried out in fixed value terms;
Net exports are the difference between exports and imports (X). As the price level in a given country increases, the volume of its export operations decreases, and the level of imports increases, i.e. goods produced in a given country become more expensive than foreign ones.
Thus, aggregate demand can be expressed by the formula:
If you look at formula (4.1) more closely, you can see that it corresponds to formula (2.1) for calculating GDP by expenditure, which we discussed in Chapter 2.
All the main components are inversely related to the price level, which determines the negative slope of the AD curve. Thus, demand at the macro level follows the same pattern as at the micro level: it will fall when prices rise and increase when they fall. This dependence follows from the equation of the quantity theory of money:
From formula (4.2) it follows that the higher the price level P, the lower (subject to a fixed supply of money M and the velocity of its circulation V) the quantity of goods and services for which Y is in demand.
The inverse relationship between the amount of aggregate demand and the price level is associated with:
With the interest rate effect (Keynes effect) - as prices rise, the demand for money increases. With a constant supply of money, the interest rate increases, and as a result, demand from economic agents using loans decreases, and aggregate demand decreases;
The wealth effect (Pigou effect) - rising prices reduces the real purchasing power of accumulated financial assets, making their owners poorer, resulting in a decrease in the volume of import purchases, consumption and aggregate demand;
The effect of import purchases is that rising prices within the country while import prices remain unchanged shifts part of the demand to imports. tailor goods, resulting in reduced exports and reduced aggregate demand in the country.
Along with price factors, aggregate demand is influenced by non-price factors. Their action leads to a shift of the AD curve to the right or left.
Non-price factors of aggregate demand include:
Factors influencing consumer expenditures of households: consumer welfare, taxes, expectations, since optimistic economic expectations of consumers and firms increase the planned volume of consumed national product;
Factors affecting the investment costs of firms: interest rates, preferential lending, opportunities for obtaining subsidies;
Changes in government policies governing government spending; in addition, aggregate demand is affected by changes in the volume of money supply in the economy made by the central bank and an increase or decrease in the level of taxation;
Changes in the global economy that affect net exports: fluctuations in exchange rates, prices on the world market, economic growth in other countries, also affect aggregate demand.
Changes in aggregate demand are shown in Fig. 4.1. A shift of the straight line AD to the right reflects an increase in aggregate demand, and to the left - a decrease.
Aggregate supply (AS - aggregate supply) is all final products (in value terms) produced (offered) in society. It shows the relationship between the value of the real national product and the price level at which the product is produced.
Graphically, the relationship between the price level and output is depicted as an aggregate supply curve.
The nature of the AS curve is also influenced by price and non-price factors. As with the AD curve, price factors change the quantity of aggregate supply and cause movement along the AS curve. Non-price factors cause the curve to shift to the left or right. Non-price supply factors include changes in technology, resource prices and volumes, taxation of firms and the structure of the economy. Thus, an increase in energy prices will lead to an increase in costs and a decrease in supply (the AS curve shifts to the left). A high harvest means an increase in aggregate supply (a shift of the curve to the right). An increase or decrease in taxes respectively causes a decrease or increase in aggregate supply.
The shape of the supply curve is interpreted differently in classical and Keynesian schools of economics. In the classical model, the economy is considered in the long term. This is the period during which nominal values (prices, nominal wages, nominal interest rates) change quite strongly under the influence of market fluctuations and are “flexible”. Real values (output volume, employment level, real interest rate) change slowly and are taken as constant. The economy operates at full capacity with full employment of the means of production and labor resources. The aggregate supply curve AS appears as a vertical line, reflecting the fact that under these conditions it is impossible to achieve further increases in output, even if this is stimulated by an increase in aggregate demand. Its growth in this case causes inflation, but not an increase in GNP or employment. The classic AS curve characterizes the natural (potential) volume of production (GNP), i.e. the level of GNP at the natural rate of unemployment, or the highest level of GNP that can be created given the technologies, labor and natural resources available in society without increasing the rate of inflation.
The aggregate supply curve can move left and right depending on the development of production potential, productivity, production technology, i.e. those factors that influence the movement of the natural level of GNP.
The Keynesian model looks at the economy in the short run. This is a period (lasting from one to three years) that is necessary to equalize prices for final products and factors of production. During this period, entrepreneurs can make a profit as a result of excess prices for final products while prices for factors of production, primarily labor, lag behind. In the short term, nominal values (prices, nominal wages, nominal interest rates) are considered “fixed”. Real values (volume of output, level of employment) are “flexible”. This model assumes an underemployed economy. Under such conditions, the aggregate supply curve AS is either horizontal or upward sloping. The horizontal line segment reflects a deep recession in the economy, underutilization of production and labor resources. The expansion of production in such a situation is not accompanied by an increase in production costs and prices for resources and finished products. The upward segment of the aggregate supply curve reflects a situation where an increase in national output is accompanied by a slight increase in prices. This may occur due to the uneven development of individual industries, the use of less efficient resources to expand production, which increases the level of costs and prices for final products in conditions of their growth.
Rice. 4.2. Aggregate Supply Curve
Both classical and Keynesian concepts describe reproductive situations that are quite possible in reality. Therefore, it is customary to combine the three forms of the supply curve into one line, which has three segments: Keynesian (horizontal), intermediate (ascending) and classical (vertical).
(Materials are based on: E.A. Maryganova, S.A. Shapiro. Macroeconomics. Express course: textbook. - M.: KNORUS, 2010. ISBN 978-5-406-00716-7)
Macroeconomics, as is known, uses aggregate indicators. Unlike individual demand aggregate demand represents the sum of all expenses of macroeconomic entities for the acquisition of final goods and services created in the national economy.
As we saw earlier, there are two counter flows in the national economic circulation model: material and monetary. Therefore, in the structure of aggregate demand, it is possible to distinguish natural-material and cost forms of aggregate demand.
Natural form aggregate demand reflects the social need of all macroeconomic entities for goods and services. Therefore, the structure of aggregate demand includes goods and services of non-productive consumption that satisfy personal and other non-productive needs, as well as the totality of all investment goods and production services.
From point of view value form Aggregate demand reflects the relationship between the volume of total output of the social product that all sectors of the economy are willing and able to purchase and the general price level. In other words, it is the demand of households, firms, the state, and the foreign sector for the total volume of final goods and services created in the national economy, which can be supplied at each price level.
The largest part of aggregate demand consists of household expenditures on the purchase of consumer goods and services, which are otherwise called consumer expenditures, or simply real consumption, and are denoted as WITH.
A more dynamic component of aggregate demand, changes in which cause fluctuations in business activity, are investment costs, i.e., the demand of entrepreneurs for investment goods to restore worn-out and increase real capital, as well as the demand of households for housing construction, denoted as I.
The third element of aggregate demand is demand from the public sector - public procurement of goods and services. It must be remembered that they do not include transfer payments to the population, as well as subsidies and subventions to the business sector, since these costs are associated with the process of redistribution of funds, and not with the costs of creating gross output. This component is designated, as is known, - G.
Another component of aggregate demand is demand from the foreign sector, more precisely - net exports – Xn– the difference between the demand of foreign agents for domestic products and the demand of domestic economic entities for foreign goods and services, i.e. export minus import.
Thus, aggregate demand as a whole can be represented as the sum of the above-mentioned elements of expenditure, which is nothing more than the value of the gross national product calculated by the expenditure method. This means that aggregate demand AD(from the English aggregate demand) is equal to Y(GNP):
AD = Y (GNP) = C + I + G + Xn.
From the definition of aggregate demand, it is clear that there is a certain relationship between the volume of gross output of goods produced and the general price level. This dependence reflects the action of law of aggregate demand. The essence of this law is that consumers (all sectors of the economy), other things being equal, will purchase a larger volume of national product the lower the general price level, and vice versa. Those. There is an inverse relationship between the real volume of gross domestic product and the price level, which can be reflected graphically in the form aggregate demand curve AD (Fig. 4.2).
This aggregate demand curve AD shows the quantity of final goods and services that consumers are willing to purchase at each possible price level. Moreover, it is necessary to take into account that this model of aggregate demand is valid provided that the amount of money remains constant and is based on the equation of the quantity theory of money - the Fisher formula:
M ∙ V = P ∙ Q
Based on this equation: Q = AD = . Hence, AD is directly dependent on the money supply and the velocity of money circulation and inversely dependent on the price level. If the money supply ( M V) unchanged, then the volume of national production ( Q) should decrease as the price level rises ( P). Therefore, the aggregate demand curve looks like a downward sloping curve.
Negative slope AD is also explained by the action of three effects:
1) interest rate effect, i.e. prices for the use of money. The fact is that an increase in the price level increases the demand for money, since more and more of it is required to carry out transactions. This, in turn, leads to an increase in the fee for using borrowed money - the interest rate. Therefore, households are postponing purchases and entrepreneurs are reducing investments. As a result, at higher prices, aggregate demand for goods and services decreases;
2) wealth effect or cash balance effect: rising prices reduce the real purchasing power of accumulated financial assets with a fixed cost (bonds, bank deposits, fixed-term accounts), which makes their owners relatively poorer and forces them to reduce spending;
3) effect of import purchases: an increase in prices within the country leads to a decrease in the value of exports and an increase in imports, which entails a decrease in aggregate demand.
The above factors are called price factors and mean a change in the amount of aggregate demand, i.e. movement along a constant curve A.D.
However, in addition to price factors, the volume of demand for goods and services is also influenced by non-price factors, the action of which ultimately leads to a change in the money supply and the velocity of money, which is graphically reflected in the shift of the curve AD to the right if aggregate demand increases, and to the left if it decreases (Figure 4.3). Basically these are all factors affecting the constituent elements AD. These include:
1) changes in consumer spending, which in turn depend on:
Dynamics of consumer welfare. Fluctuations in property values lead to changes in decisions about purchasing goods and services. For example, a sharp increase in the price of securities owned by households will cause an increase in consumer spending, and, therefore, lead to an increase in aggregate demand;
Dynamics of consumer debt. After all, in order to pay off increased debts, it is necessary to reduce current consumption, and, consequently, reduce AD;
Dynamics of taxes on consumer income, because the higher the income tax rate, the lower the net income, which means consumer spending and AD generally;
Consumer expectations, especially in conditions of very high inflation;
2) changes in investment spending, which are influenced by:
Interest rate dynamics not related to price changes (for example, due to changes in the money supply). An increase in the interest rate leads to an increase in the price of loans, and this, given a constant price level and the inability to increase profits due to rising prices, will inevitably lead to a reduction AD;
Expected returns on investment. If making a profit is problematic, then investment costs are reduced, reducing and AD;
The presence of excess production capacity, which is a factor in slowing down investment;
Technology development. The emergence of new technologies forces entrepreneurs to increase investment spending;
Dynamics of taxes on the income of entrepreneurs and the implementation of tax incentives for investments. An increase in the tax rate reduces the profits of firms, reducing incentives to invest; the introduction of tax breaks on investment, on the contrary, increases AD;
3) changes in government procurement volumes also have a direct impact on the position of the aggregate demand curve;
4) changes in net exports because of:
Price fluctuations in the markets of other countries,
Dynamics of national income in foreign countries,
Exchange rate fluctuations;
5) changes in the money supply. An increase in the money supply in the country in the short term leads to a decrease in interest rates, improved lending conditions, and, consequently, an increase in investment and growth AD.
Thus, there are a huge number of factors influencing the volume of real gross domestic product that macroeconomic entities are willing and able to purchase at a given price level.
16. The Keynesian model assumes:
a) vertical AS curve at the level of potential GDP;
b) a horizontal AS curve at a certain price level corresponding to a level of GDP below potential;
c) an AS curve with a slight positive slope, reflecting the effect of interest rates;
17. The classical model explains the simultaneous decline in GDP and the price level:
a) only shift AD to the left;
b) only by shifting AD to the right;
c) only by a decrease in potential GDP;
d) a decrease in aggregate demand and potential GDP.
18. The classical model explains the decline in GDP while maintaining the price level:
a) a simultaneous decrease in aggregate demand and potential GDP;
b) an increase in aggregate demand with constant potential GDP;
c) an increase in potential GDP with constant AD;
d) an increase in AD with a decrease in potential GDP.
19. What happens in the economy in the long run with production volume at the potential level with an increase in government spending:
a) production volume increases at a constant price level;
b) the general price level increases with a constant volume of production;
c) the volume of production does not change, the general price level decreases;
20. The long-term consequences of an increase in the money supply are expressed in:
a) an increase in the price level without changing the volume of output;
b) increasing output without changing the price level;
c) parallel increase in prices and output;
d) no changes in both the price level and output volumes.
21. When all resources are used and the potential volume of GDP is reached, then an increase in aggregate demand leads to:
a) increasing the supply of goods;
b) lower prices with a constant supply of goods;
c) rising prices with constant supply.
22. Household personal consumption expenditures are:
a) household expenditures on the purchase of durable goods and services;
b) household expenses for the purchase of durable and short-term goods and services;
c) transfer payments and taxes;
d) household expenditures on the purchase of goods and services and personal taxes.
23. The classical model assumes that the aggregate supply (AS) curve will be:
a) horizontal at the price level determined by aggregate demand;
b) horizontal at the price level, determined by the interest rate and government policy;
c) vertical GNP at an arbitrary level;
d) vertical at the level of potential GNP.
24. If the state tightens requirements for environmental conservation, this causes:
a) an increase in production costs per unit of output and a shift of the aggregate supply curve to the right;
b) an increase in production costs per unit of output and a shift of the aggregate supply curve to the left;
c) an increase in production costs per unit of output and a shift of the aggregate demand curve to the left;
d) a fall in production costs per unit of output and a shift of the aggregate demand curve to the left.
25. Government policy to increase aggregate supply includes:
a) reduction in consumer imports;
b) narrowing of the market for goods and services;
c) increasing the marketability of the national economy;
d) nationalization of private enterprises.
26. An increase in the price level and a simultaneous increase in the unemployment rate in the country
a) impossible;
b) are possible only in a centralized system;
c) may be due to a decrease in aggregate supply;
D) may be caused by a fall in aggregate demand.
27. The classical model explains the decrease in GNP with a decrease in the price level:
a) a simultaneous decrease in aggregate demand and potential GNP;
b) an increase in aggregate demand with constant potential GNP;
c) an increase in potential GNP with constant aggregate demand.
28. Aggregate demand in macroeconomics is:
a) government spending and investment demand of enterprises;
b) household demand and net exports;
c) demand of all macroeconomic subjects of the economy;
d) household demand and enterprise investment demand.
29. If the economy is initially in a state of long-term equilibrium, then an increase in the velocity of money can lead to:
a) a fall in output in the short term and a fall in prices in the long term;
b) a fall in output in the short term and an increase in prices in the long term;
c) growth in output in the short term and rising prices in the long term;
d) an increase in output in the long term and an increase in prices in the short term.
30. According to the provisions of the classical model:
a) the level of aggregate demand is determined by the volume of production;
b) prices and nominal wages are rigid;
c) the aggregate supply curve is vertical and cannot shift either to the right or to the left;
d) investments and savings in the economy are determined by different factors and cannot be balanced by changes in the interest rate.
It has long been noted that the quantity of goods that buyers request from sellers for purchase (let’s call it the quantity of demand) directly depends on the price level at which such a purchase is possible. The quantity of demand represents the quantity of a particular type of product (in physical measurement) that buyers are willing to purchase over a given period of time (month, year) at a certain price level for this product. Economists call the dependence of the amount of purchases on the commodity market on price levels demand. Demand is the dependence of the amount of demand on the commodity market that has developed over a certain period of time on the prices at which goods can be offered for sale. Demand characterizes the state of the market, or rather one of its most important components, the economic logic of buyer behavior. In reality, this logic is manifested in the amount of demand (number of purchases) at a given price level. By studying how buyers react to changes in the prices of goods, economists formulated the law of demand. The essence of the law of demand is that an increase in prices usually leads to a decrease in the quantity demanded, and a decrease in prices leads to an increase (all other things being equal). The manifestation of the law of demand is associated with a number of important circumstances. People buy the vast majority of goods by assessing the price-utility ratio for each specific good. If a person’s need for this good is not fully satisfied, then a decrease in price leads to an increase in the assessment of the relative desirability of the good. This means that it leads to an increase in demand for it. This pattern of changes in the desirability of a product (good) leads to the fact that although a decrease in price allows the buyer to purchase a larger quantity of the product, the desirability of each additional unit becomes less and less due to the gradual saturation of the buyers' needs for these goods.
What other factors, besides the usefulness of a product and its price, influence the formation of demand? There are five such factors: income of buyers; prices for complementary or substitute products; expectations regarding future price movements; number and age of buyers; habits, tastes, traditions and preferences of customers. In addition, demand may be influenced by some other factors (seasonality, government policy, evenness of income distribution, advertising, etc.).
Now let's move directly to the concept of aggregate demand. We can say that aggregate demand (AD) is the sum of all individual demands for final goods and services offered in the product market. The following also follows from this: aggregate demand is a model representing various volumes of goods and services (i.e., real volume of production) that consumers are able and willing to purchase at any price level.
Buyers in the goods market are four macroeconomic entities: households, firms, the state and abroad.
Household demand dominates the goods market. It accounts for more than half of final aggregate demand. Observing the behavior of households, it can be stated that the factors determining their demand in the goods market include:
- 1) income from participation in production;
- 2) taxes and transfer payments;
- 3) size of property;
- 4) income from property. Taking into account that the household sector is an aggregate value, two more factors should be added to these factors:
- 5) the degree of differentiation of the population by income level and size of property and
- 6) size and age structure of the population.
The first two of the listed series of factors are combined into the concept of “disposable income”. The last two are exogenous parameters in the short run. Depending on which of the remaining factors - disposable income, size of property or its profitability - is considered the most significant, it is possible to construct several varieties of the household demand function in the goods market, called the “consumption function”.
State demand. The government buys products made in the private sector to produce public goods. Against the background of the historical development of a market economy, a pronounced tendency is revealed to increase the state’s share in the gross product.
Since the economic activity of the state, unlike the economic activity of the private sectors, does not have a clearly defined optimality criterion, it is difficult to identify the main factors that unambiguously determine the volume of government spending. The state budget of the country is approved by parliament, as a rule, a year in advance, and thus the main expenditure items of the state are given.
In addition to the direct influence of the state on the market of goods through their purchase, it indirectly influences aggregate demand through taxes and loans (issuing bonds). With changes in the amount of taxes, the amount of disposable income changes, and, consequently, the consumer demand of households. State operations in the securities market are reflected in the level of the real interest rate and, as a result, on the investment demand of entrepreneurs.
Demand from abroad. Foreign demand in the goods market of a certain country determines the volume of the latter's exports and depends mainly on the ratio of prices for domestic and foreign goods and the exchange rate of national currencies. Both of these factors are combined into the “real terms of exchange” indicator. It shows how many foreign goods a country can receive in exchange for a unit of its own good. When B increases, we say that the country's real exchange conditions are improving, since more foreign goods can be obtained per unit of domestic good. However, for foreign countries this means an increase in the price of goods from a given country, and the latter’s exports, other things being equal, will decrease. Foreign countries not only buy, but also sell goods on the market of a given country. In models designed to determine the conditions for achieving equilibrium in the national economy (internal equilibrium), for the sake of simplicity, it is assumed that the volume of supply abroad in the national market of goods is completely elastic, i.e., at a given price level, foreign countries satisfy any volume of demand of residents of a given country for imported goods. For simplicity, it is also assumed that only consumer goods are imported.
The volume of household demand for imported goods is determined by the same factors as the volume of demand for domestic goods.
The demand for investment is the most volatile part of the aggregate demand for goods. Investments respond most strongly to changes in economic conditions. On the other hand, it is the change in the volume of investment that most often causes market fluctuations.
The specificity of the impact of investments on the economic situation is that at the time of their implementation, the demand for goods will increase, and the supply of goods will increase only after some time, when new production capacities come into operation.
Depending on what factors determine the volume of demand for investment, the latter are divided into induced and autonomous.
Induced investments. Investments are called induced if the reason for their implementation is a sustainable increase in demand for goods.
When the demand for goods increases with full utilization of production capacities used at optimal intensity, then at first additional products can be produced due to more intensive operation of existing equipment. But if increased demand persists for a long time, then it is in the interests of entrepreneurs to increase production capacity in order to produce additional products at the lowest cost.
To determine the amount of investment that will ensure the expansion of the production base necessary to meet increased demand, you need to know the incremental capital intensity of production - a coefficient showing how many units of additional capital are required to produce an additional unit of output.
Thus, induced investment is a function of the increase in national income. The incremental capital intensity ratio is also called the accelerator. With a uniform increase in national income, the volume of induced investment is constant. If income grows at a variable rate, then the amount of induced investment fluctuates. When national income declines, investment becomes negative.
Autonomous investments. However, it often turns out to be profitable for entrepreneurs to make investments even with a fixed national income, i.e., with a given aggregate demand for goods. This is primarily an investment in new equipment and improving product quality. Such investments most often themselves become the cause of an increase in national income, but their implementation is not a consequence of an increase in national income, and therefore they are called autonomous.
In Keynesian theory, aggregate demand is calculated using the formula
C – total personal consumption expenditures;
Jg – gross domestic private investment;
Xn – volume of net exports;
G – government procurement of goods and services.
The aggregate demand model, represented as a curve, shows the different quantities of goods and services that consumers, businesses, and governments are willing to buy at any possible price level.
Aggregate demand model
There is an inverse relationship between the price level and the volume of national production. Other things being equal, the lower the price level, the greater the real volume of national output that will be purchased by consumers at home and also abroad.
Non-price factors of aggregate demand include:
- 1. Changes in consumer spending (C):
- a) consumer welfare;
- b) consumer expectations;
- c) consumer debt;
- d) taxes.
- 2. Changes in investment costs (Jg):
- a) interest rates that change regardless of the price level;
- b) expectation of profit from investments;
- c) taxes on enterprises;
- d) technology;
- e) excess capacity.
- 3. Government expenditure: government purchases of goods and services (G).
- 4. Expenditures on net exports (Xn): which in turn depend on the national income of other countries, on the competitiveness of domestic goods and on the exchange rate of the national currency.
The first non-price factor is a change in consumer spending that is not associated with a change in prices. An increase in real income or consumer expectations of an increase in income can lead to an increase in aggregate demand. The inflationary rise in prices expected by the consumer and the increase in taxes lead to a decrease in aggregate demand. Consumer debt (purchases on credit) also changes the quantity of aggregate demand: a high level of consumer debt may force the consumer to reduce current spending to pay off debts, which will reduce the quantity of aggregate demand. The following factors influence changes in consumer spending:
Consumer welfare. Wealth consists of all the assets that consumers own: financial assets such as stocks and bonds, and real estate (houses, land). A sharp decrease in the real value of consumers' assets leads to an increase in their savings (to a decrease in purchases of goods), as a means of restoring their well-being. As a result of a reduction in consumer spending, aggregate demand decreases and the aggregate demand curve shifts to the left. And, conversely, as a result of an increase in the real value of material assets, consumer spending at a given price level increases. Therefore, the aggregate demand curve shifts to the right. In this case, we do not mean the wealth effect discussed earlier, or the effect of real cash balances, which assumes a constant aggregate demand curve and is a consequence of changes in the price level. In contrast, changes in the real value of the material assets in question do not depend on changes in the price level; it is a non-price factor that shifts the entire aggregate demand curve.
Consumer expectations. Changes in consumer spending patterns depend on the predictions consumers make, for example, when people believe that their real income will increase in the future, they are willing to spend a larger proportion of their current income. Therefore, at this time, consumer spending increases (savings decreases at this time) and the aggregate demand curve shifts to the right. Conversely, if people believe that their real incomes will decrease in the future, then their consumption expenditures, and therefore aggregate demand, will decrease.
Consumer debt. A consumer's high level of debt resulting from past credit purchases may force him to cut back on current spending to pay off existing debts. As a result, consumer spending will decrease and the aggregate demand curve will shift to the left. Conversely, when consumers have relatively little debt, they are willing to increase their current spending, which leads to an increase in aggregate demand.
Taxes. A decrease in income tax rates entails an increase in net income and the number of purchases at a given price level. This means that a tax cut will shift the aggregate demand curve to the right. On the other hand, an increase in taxes will cause a decrease in consumer spending and a shift of the aggregate demand curve to the left.
The second factor is business investment expenses. An increase in business investment expenses leads to an increase in aggregate demand, and conversely, a decrease in such expenses leads to a decrease in aggregate demand. The reasons for increasing the size of investments can be: a decrease in interest rates, an expected increase in profits, a reduction in taxes, the acquisition of new technologies (which reduces costs and increases profits) and the reserve capacity of the enterprise (increasing excess capacity in the enterprise will reduce investment costs).
Interest rates. All other things being equal, an increase in the interest rate caused by any factor other than a change in the price level will lead to a decrease in investment spending and a decrease in aggregate demand. In this case, we do not mean the so-called interest rate effect, which arises as a result of changes in the price level.
Expected returns on investment. More optimistic forecasts for returns on invested capital increase the demand for investment goods and thereby shift the aggregate demand curve to the right. For example, a perceived increase in consumer spending may in turn stimulate investment in hopes of future profits. Conversely, if the prospects for profits from future investment programs are rather dim due to an expected decline in consumer spending, then investment costs tend to fall. Consequently, aggregate demand will also decrease.
Business taxes. An increase in corporate taxes will reduce the after-tax profits of corporations from capital investment, and, consequently, reduce investment spending and aggregate demand. Conversely, a tax cut will increase after-tax returns on investment and possibly increase investment spending, as well as push the aggregate demand curve to the right.
Technologies. New and improved technologies tend to stimulate investment spending and thereby increase aggregate demand.
Excess capacity. An increase in excess capacity, that is, unused capital on hand, restrains the demand for new capital goods and therefore reduces aggregate demand. Simply put, firms operating below capacity have little incentive to build new plants. Conversely, if all firms find that their excess capacity is decreasing, they are willing to build new plants and buy more equipment. Consequently, investment spending increases and the aggregate demand curve shifts to the right.
And two more non-price factors influence changes in aggregate demand - government spending (direct dependence of aggregate demand on this factor) for the purchase of finished goods and services. An increase in government purchases of the national product at a given price level will lead to an increase in aggregate demand as long as tax revenues and interest rates remain unchanged. Conversely, a decrease in government spending will lead to a decrease in aggregate demand.
And net export costs. When we talk about levers that shift aggregate demand, we mean changes in net exports caused not by changes in the price level, but by other factors. The increase in net exports (exports minus imports) resulting from these “other” factors shifts the aggregate demand curve to the right. The logic of this statement is as follows. First, higher levels of national exports create higher demand for American goods abroad. Secondly, the reduction in our imports implies an increase in domestic demand for domestically produced goods. First of all, the volume of net exports changes the national income of foreign countries and exchange rates.
National income of other countries. An increase in the national income of a foreign country increases the demand for our country's goods and therefore increases the aggregate demand in our country. Since when the level of income in foreign countries increases, their citizens have the opportunity to buy more goods, both domestically produced and those produced in our country. Consequently, our exports increase along with the rise in national income levels of our trading partners. A decrease in national income abroad has the opposite effect: our net exports decline, shifting the aggregate demand curve to the left.
Exchange rates. Changes in the exchange rate of the dollar against other currencies are the second factor that affects net exports and, consequently, aggregate demand.
