Analyzing Aggregate Demand, Supply, and Consumer Spending

Macroeconomic Forces: Demand, Supply, and Consumer Drivers

The internal forces are determined by the market behavior of economic agents in a country, and are expressed through the free play of aggregate demand and aggregate supply. The average level of prices is the weighted average of prices of all goods and services in an economy. It is difficult to change the productive capacity of a country in the short term, so aggregate supply is often constrained by aggregate demand. Aggregate supply is subject to the behavior and expectations of economic agents, and can change from one moment to another.

Aggregate Demand (DA)

Aggregate Demand (DA) is the total expenditure, at a determined average price level, performed in an economy by families, businesses, the public sector, and foreigners. The formula is:

Aggregate Demand Formula

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

Aggregate demand is the value of final goods and services that economic players are willing to buy, while GDP is the value of the aggregate demand actually purchased. Aggregate demand reflects expectations for spending, and GDP reflects consummated results. The result is the same, and in macroeconomics, these terms are often synonymous. The representation is the aggregate demand curve. Aggregate demand increases as prices fall, and vice versa.

The Aggregate Supply (OA)

The aggregate supply (OA) describes the amount of production that companies would be willing to sell, given an average level of prices and determined costs. This is a core problem in macroeconomics.

Determinants of Aggregate Supply

The aggregate supply is influenced by:

• The Average Level of Prices

  If the price level is lower, profits erode, and the opposite occurs when prices increase. If the prices of goods and services sold are lowered, companies will have to cut costs and lower the level of production.

• Production Costs

  When the price of resources used by businesses to produce rises, benefits fall. Production costs include factor costs, production costs, and the costs of the technology used.

• Business Expectations

  The number of units produced may depend on their expectations, which condition business objectives.

Factors Determining Consumer Behavior

Several factors determine consumer spending:

• Disposable Income of Each Year

  This is the factor that most influences consumption in a country. Higher income leads to increased consumption, and vice versa. Consumption is an increasing function of income.

• Permanent Income

  This is the level of income that a household perceived once temporary fluctuations are eliminated. Permanent income influences consumption and is mainly due to the average income one has, regardless of individual events.

• The Life-Cycle Hypothesis

  This hypothesis supposes that people save to standardize the amount of consumption throughout their lives. Many aspire to have a good retirement.

• The Wealth Effect (Riqueza Effect)

  Wealth also influences the amount of consumption, apart from salary. For example, receiving a prize (lottery).