question_answer

What is aggregate demand? State its components.

Or

Explain how controlling money supply is helpful in reducing excess demand.

Answer:

Aggregate demand: Aggregate demand is the total demand for final goods and services in the economy. It also refers to the total amount of money which all sectors are ready to spend on purchase of goods and services. Aggregate demand is the total expenditure on consumption and investment.

Components of AD are:

(a) Household (or private) consumption demand (C): Value of goods and services that households are able and willing to buy.

(b) Private Investment demand (I): This refers to planned expenditure on buying of new capital assets like machines, buildings and raw material by private entrepreneur. This investment is done to increase production capacity in future.

(c) Government demand for goods and services (G): It is the government expenditure on purchase of consumer and capital goods to fulfil common needs of the society,

(d) Net exports (exports-imports) demand (X-M): Net exports is the difference between exports of goods and services and imports of goods and services during a given period. Net exports show the demand of foreign countries for our goods and services over our demand for foreign countries goods and services. This strengthens the income, output and employment process of our economy

\[AD=C+I+G+(XM)\]

Or

When the planned aggregate expenditure is greater than the available output at full employment level, this situation is termed as excess demand. It leads to inflationary gap in the economy. It arises because of increase in money supply due to deficit financing leading to increase in consumption demand or an increase in autonomous investment without the corresponding increase in savings. So, there is a need to reduce the money supply in the economy in order to curb the demand levels in an economy. As the purchasing power will reduce, aggregate demand levels will come down. This can be done both by using monetary and fiscal policy.