What are the components of the aggregate demand (AD) curve?
The correct answer and explanation is:
The components of the aggregate demand (AD) curve include consumption (C), investment (I), government spending (G), and net exports (NX), which is the difference between exports (X) and imports (M).
- Consumption (C): This represents the total spending by households on goods and services. It is influenced by factors such as income levels, interest rates, and consumer confidence. Higher consumer spending leads to an increase in aggregate demand, while lower spending can reduce it.
- Investment (I): This refers to the spending by businesses on capital goods like machinery, buildings, and equipment. Investment is affected by interest rates, business expectations about future profits, and government policies such as tax incentives. A rise in investment increases aggregate demand as businesses expand production capacity.
- Government Spending (G): This includes all government expenditures on goods and services such as infrastructure projects, education, and defense. Unlike consumption and investment, government spending is determined by fiscal policies and is generally not sensitive to interest rates. An increase in government spending shifts the aggregate demand curve to the right.
- Net Exports (NX): This is the difference between a country’s exports and imports. A country’s net exports increase if its goods and services are in demand abroad, or if domestic currency depreciates, making exports cheaper. On the other hand, an increase in imports or a decrease in exports shifts the aggregate demand curve to the left.
All these components contribute to the overall level of demand for a country’s goods and services at different price levels. The AD curve slopes downward, reflecting the inverse relationship between the price level and the quantity of goods and services demanded. When the price level rises, consumption and investment decrease, leading to a lower aggregate demand.