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Aggregate Demand

The Definition and Components of Aggregate Demand

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Aggregate Demand

Demand is driven by consumers.

Aggregate demand is measured by a country's:

  • Consumer spending.
  • Investment spending by business. This only includes spending on equipment, buildings, and inventory.
  • Government spending on goods and services. This does not include transfer payments, such as Social Security, Medicare and Medicaid. This doesn't really increase demand, it just shifts it from one group (taxpayers) to another (beneficiaries).
  • Exports, which are demanded by other countries.
  • Minus imports, which are demands made by U.S. residents that can't be met by domestic production. Therefore, the demand leaves the economic system of the U.S.

This measurement of aggregate demand is usually expressed in the following mathematical formula:

AD = C + I + G +(X-M)

Measured this way, aggregate demand in the U.S. is over $15.454 trillion as of the first quarter of 2012. Fortunately, this formula for aggregate demand is the same as the one used by the Bureau of Economic Analysis (BEA) to measure Gross Domestic Product (GDP). Here's how to do it using the formula given:

  • Use Table 1.1.5 GDP.
  • C = Personal Consumption Expenditures of $11,009.5 billion.
  • I = Gross Private Domestic Investment of $2,046.5 billion.
  • G = Government Consumption Expenditures of $3,018.2 billion.
  • (X-M) = Net Exports of Goods and Services of -$620.1 billion.
Add them together and the total is $15,454 billion or $15.454 trillion. (Source: BEA, GDP and Personal Income Accounts)

America Has Been the World's Best Customer

U.S. demand is nearly 20% of the world's total demand of $78.9 trillion. It's roughly on a par with that of the European Union. It's more than that of the next largest country, China, which has a demand of $11.29 trillion. Demand from the next two countries on the list is much less: India at $4.4 trillion, and Japan at $4.3 trillion. (Source: CIA World Factbook, 2011 GDP, Purchasing Power Parity)

Right now countries need America because we are the largest importer, at $2.3 trillion, more than the EU ($2 trillion), or China ($1.7 trillion). Because of this role, all countries have an interest in maintaining good relations with the U.S., and in keeping our economy healthy. (Source: CIA World Factbook, 2011 estimate)

Why the U.S. Imports so Much

The key component of demand is consumer goods and services. Whereas the U.S. supplies all of its own services, it imports goods that can be made more efficiently overseas, such as industrial supplies, oil, telecommunication equipment, autos, clothing and furniture. It is often said that the U.S. has lost its competitive edge in producing these products, and has become a service-oriented economy. Demand drives economic growth, and growth drives demand. Here's how it works. As incomes rise, people are able to buy more. As people buy more, companies can make more, and then pay employees more. The ideal situation is healthy growth without inflation, .

U.S. Demand Could Decline

Since demand is dependent on personal income and wealth, a decline in either lowers demand. Even before the 2008 financial crisis, the median net worth per family rose only 1.5% from 2001 to 2004 according to a Federal Reserve report. Since net worth did not keep up with inflation during these years, the average household felt poorer. To meet demand, families took advantage of low-interest home equity loans. As a result, overall debt servicing took a larger percent of family income. In fact, the number of late payments (60+ days) increased, especially among the bottom 80% of the income distribution. When housing prices fell, home equity dried up. Some homeowners walked away, while many more lost their homes when they lost their jobs. As a result, consumer debt levels have dropped. A combination of less wealth, lower income and reduced debt was a decline in U.S. demand. As measured by GDP, demand dropped .3% in 2008, and (For more detail, see Current GDP Statistics)

Foreign Demand Could Increase

Before the 2008-2009 recession, the Organization for Economic Cooperation and Development (OECD) predicted demand in China, India and Russia would grow, thanks to increasing population and personal income. Demand in the U.S., Japan, and Brazil was slowing, even before the recession. The U.K. and the Euro area had mixed indicators, which portended moderate growth. This trend should resume after the recession is over.
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