What this lesson teaches
I can explain how changes in the determinants of C, I, G and (X - M) shift aggregate demand.
Syllabus 9570, 3.1.2(b). Aggregate Demand and Aggregate Supply: How AD is affected by changes in the determinants of C, I, G and (X - M)
Make a guess
Singapore exports $10 billion more electronics, but many parts in them were imported. Does Singapore's AD rise by $10 billion?
- No, it falls, because imports go up.
- Yes, by the full $10 billion, because exports are part of AD.
- No, by less, because imported parts are foreign output.
Show the answer
No, by less, because imported parts are foreign output.
Only the value added in Singapore raises its output. The imported parts leak out as imports, so AD rises by less than the export value.
Government spending depends on policy; exports depend on world income, prices and exchange rates.
Government spending depends on the Budget: decisions about healthcare, education, defence and infrastructure.
Exports depend on foreign incomes, the prices of our goods relative to others', the exchange rate and non-price factors such as quality and reliability.
Imports depend on domestic income, relative prices and firms' need for foreign inputs. Singapore imports most of its food, energy and many components used in its exports.
Because exports contain many imported parts, a rise in exports raises Singapore's AD by less than the full value of the exports.
- X depends on
- Foreign incomes, relative prices, exchange rates, quality.
- M depends on
- Domestic income, relative prices, need for inputs.
Worked example: More foreign orders for logistics
Foreign demand for Singapore's logistics services rises. Firms also buy imported equipment that will raise productivity once installed next year.
- Now: higher exports of logistics services raise AD.
- The imported equipment is mostly foreign output, so it adds little to AD directly; local installation work does add to it.
- Next year: the equipment raises productive capacity, which shifts AS right.
Watch out for this
A rise in exports raises AD by the full value of the exports.
Many Singapore exports contain imported parts. Only the local value added raises domestic output.
Check your understanding
Incomes in Singapore's major trading partners rise. What happens to Singapore's AD?
- It falls, because Singaporeans buy more imports.
- It rises, because foreigners buy more exports.
- It is unchanged, because foreign incomes do not affect Singapore.
Show the answer
It rises, because foreigners buy more exports.
Right. Higher foreign income raises demand for Singapore's exports.