What this lesson teaches
I can name the parts of aggregate demand: consumption, investment, government spending and net exports.
Syllabus 8843, 3.1.1(a). Aggregate Demand and Aggregate Supply: Aggregate Demand (AD) and its components: consumption (C), investment (I), government spending (G) and net exports (X - M)
Make a guess
The government gives every household a $300 cash payout. Does government spending (G) in AD rise by the payout?
- Yes, but just for the share paid to poorer households.
- No. A cash payout is a transfer, not spending on output.
- Yes. Any money the government pays out counts as G.
Show the answer
No. A cash payout is a transfer, not spending on output.
G counts government purchases of goods and services. A payout raises AD only when households spend it, through consumption.
AD = C + I + G + (X - M): consumption, investment, government spending and net exports.
Aggregate demand is total planned spending on a country's goods and services at each general price level.
C is household consumption. I is investment: firms buying machines, buildings and stock. G is government spending on goods and services, not including transfers such as cash payouts. (X - M) is net exports: foreigners' spending on our exports minus our spending on imports.
For Singapore, exports are by far the largest source of demand, because the domestic market is small. Total trade is more than three times GDP.
That makes Singapore's AD very sensitive to what happens in the world economy.
- AD
- C + I + G + (X - M).
- Singapore
- Exports are the largest part of AD.
Worked example: Which spending counts?
In a year, C = 500, I = 120, G = 180, X = 150 and M = 100. The government also gives households $50 in cash payouts.
- AD = 500 + 120 + 180 + (150 - 100) = 850.
- The $50 cash payout is not in G; it is a transfer. It only affects AD if households spend it, through C.
- Imports are subtracted because that spending buys foreign output, not local output.
Watch out for this
Government cash payouts are part of G.
G is government spending on goods and services. Cash payouts are transfers; they affect AD only when households spend them.
Check your understanding
Why are imports subtracted in AD = C + I + G + (X - M)?
- Imports harm local firms, so spending on them is counted as a minus in AD.
- Because spending on imports buys foreign output, not domestic output.
- Imports are a type of saving, because the money leaves the household.
Show the answer
Because spending on imports buys foreign output, not domestic output.
Right. C, I and G include some imported goods, so M removes them.