Macroeconomic Fundamentals: Aggregate Demand, Supply, and Policies
Aggregate Demand (AD)
AD refers to the total amount spent across different economic sectors over a period. Factors influencing AD include prices of goods, production factors, and macroeconomic policies. The AD curve shows the relationship between the general price level and aggregate expenditure, encompassing all economic agents at different price levels.
Aggregate Supply (OA)
OA is the total goods and services that companies are willing to produce and sell in a given period, based on prices, production capacity, costs, and market conditions. Factors include the price level businesses can accept and the economy’s potential production capacity, influenced by existing productive factors. The OA curve represents the quantity of goods and services companies are willing to produce at each price level, assuming other determinants remain constant.
Macroeconomic Equilibrium
Macroeconomic equilibrium occurs at the real GDP and general price level where supply meets demand.
Consumption
Consumption is usually the largest component of AD. It includes spending on durable and non-durable goods. Factors influencing consumption include disposable income (as per the permanent income and life-cycle hypotheses) and the wealth effect.
Investment
Investment refers to acquiring capital goods that indirectly satisfy human needs by contributing to future production. Functions of investment include increasing aggregate demand when companies acquire capital goods and boosting the country’s productive capacity. Types of investment include:
- Plant and equipment: Durable goods acquisition for business development.
- Construction: Investment in building.
- Inventories: Changes in stock levels.
Factors influencing investment include business revenues, costs (interest rates and taxes), installed capacity, and future expectations. The multiplier effect of investment is the total increase in economic expenditure resulting from an increase in investment (I * 1/(1-MPC)).
Savings
Savings is the portion of disposable income not consumed (S = Y – C, where Y is income and C is consumption, thus Y = S + C). Savings enable business investment and improve future living standards.
Economic Cycle
The economic cycle is a fluctuating sequence of expansion and contraction in real GDP around potential GDP. Phases include:
- Trough: The lowest point of the cycle, with low demand relative to productive capacity.
- Recovery: Upswing driven by capital replacement, increasing investment and demand, boosting production.
- Peak: The highest point, where increasing production becomes difficult due to resource constraints.
- Recession: Downturn where investments become less profitable.
Theme 11: Economic Policies
Monetary Policy
Monetary policy, controlled by the European Central Bank (ECB), influences interest rates and credit conditions, affecting interest-sensitive sectors like investment and consumption, thus impacting AD.
Fiscal Policy
Fiscal policy involves government decisions on public expenditure and taxation levels.
Foreign Policy
Foreign policy uses tariffs and quotas to boost net exports.
Supply-Side Policies
These policies aim to promote work incentives, production, and technological improvements to enhance efficiency and productivity.
Fiscal Policy Details
Fiscal policy includes government programs related to purchasing goods and services, transfer payments, and taxes. Public spending is a variable that can increase or decrease AD. Discretionary fiscal policies include public works programs (public investment to employ the unemployed and provide infrastructure) and public employment projects (hiring unemployed for short periods).
General State Budgets (PGE)
PGE Documents: These documents, prepared by the government, outline state revenue and expenditure for the upcoming year. Content includes general economic goals, detailed income and expenditure for each entity, and microeconomic policy instruments for budget implementation.
PGE Principles
- Competitiveness: The executive prepares the budget, which is then presented to the legislature for approval.
- Universality: Budgets cover all public sector revenues and expenditures.
- Specialty: Budgeted amounts are spent only for their designated purposes.
- Temporality: Budgets refer to a specific period, usually a calendar year.
PGE Expenses
- Current: The largest portion, for providing public services.
- Investment: For maintaining and increasing the country’s productive capital.
- Other: Bank transfers to individuals, subsidies to companies.
Classification of PGE Income
- Tax Revenue: Compulsory payments by taxpayers.
- Direct Taxes: Taxes on income.
- Indirect Taxes: Taxes on consumption of goods and services.
- Non-Tax Revenue: Social security contributions, income from assets, sale of public assets, capital transfers.
- Extraordinary Revenue: Obtained when the public sector needs additional funds.
Budget Balance and Financing
The budget balance is affected cyclically; during economic downturns, tax revenue decreases, and public spending may increase.