The Concept of

Aggregate Demand In
India

1
 What is Aggregate Demand
Aggregate demand refers to the total amount that different sectors
in the economy are willing to spend in a given period.

It is the sum spending by consumers, businessmen, Government

and other agencies in the country i.e. It measures the total
spending by all different entities in the economy.

It depends upon:
Level of prices
Monetary policy
Fiscal policy
Other factors

Source: Introductory Economic Theory XII – 7th edition 2

 Determinants of aggregate demand
AD = C + I + G + (X-M)
Where; AD = Aggregate demand

C=
I = Investment
Consumption

(X-M) = (Export
– Import)
G = Government
demand i.e. Net income
from foreign
transactions

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Source: Introductory Economic Theory XII – 7th edition
 A. Consumption (C)
The amount which consumers are willing to spend on the purchase of goods and services
for satisfaction of their wants

Those goods & services which are utilized for final satisfaction of human wants E.g. TV,
car, rice, milk

Consumption depends on the following factors:

 Level of household income

 Creditfacilities
 Outlook for future
 Disposable income
 Stock of wealth
 Advertisement
 Availability of goods & services
 Cultural attitude
 Average size and composition of households
Source: Introductory Economic Theory XII – 7th edition 4
 B. Investment Demand
The use of saving for the purpose of production made by an individual or a business
firm.

Aim: acquire capital goods or assets E.g. Machinery plant, factory buildings etc.

Investment expenditure also made by Govt. To increase stock of Social and economic
overheads
Private
investment
Types:
Autonomous Public
investment investment

Induced Foreign
investment investment

Gross
Net investment
investment
Source: Introductory Economic Theory XII – 7th edition 5
 B. Investment Demand

Level of
saving

Expectation
Rate of
about future
interest
changes

DETERMINANTS
Marginal
Stock of
efficiency of
fixed capital
capital

Innovation
Supply of
and
money and
technology
bank credit
advance

Source: Introductory Economic Theory XII – 7th edition 6

 C. Government Demand
Government Expenditure

Consumption Expenditure by Govt. Investment expenditure by Govt.

When these expenditures are incurred by the Govt, it increases aggregate

demand. When the Govt makes payment for goods and services purchased
and when the amount received by factors of production is used by factors
for purchase of goods & services produced in the country, it increases the
demand for goods & services.

Source: Introductory Economic Theory XII – 7th edition 7

 D. Foreign Demand (X-M)
Export: Selling of goods & services – capital & consumer goods by one
country to different countries of the world

Import: Purchase of goods & services – capital & consumer goods by a

country from different countries in the world. Increases agg. demand

Net earnings from foreign transaction: Export – Import

This can be positive, negative or even zero

Source: Introductory Economic Theory XII – 7th edition 8

 Components of aggregate demand
Total
Total Spending
Spending On
On

Consumption
Consumption Investment
Investment Consumption
Consumption & & Consumption
Consumption & & All
goods All
goods && services
services goods
goods and
and Investment
Investment goods
goods investment
investment goods
goods -- Imports
Imports
by the private + services + +
by the private + services by
by the
the + and
and services by
services by + and
and services by
services by (M)
(M)
sector
sector (C)
(C) private sector
private sector Government
Government (G)
(G) foreigners (X)
foreigners (X)
(I)
(I)

Private Net
Net External
External Sector
Sector
Private Sector
Sector Demand
Demand Public
Public Sector
Sector Demand
Demand Demand
Demand

Aggregate
Aggregate Demand
Demand =
=CC+
+ II +
+GG+
+ (X
(X –– M)
M)

9
Source: indiabudget.nic.in/es2009-10/chapt2010/chapter01.pdf 10
 Change in Aggregate Demand over the
years

Source: indiabudget.nic.in/es2009-10/chapt2010/chapter01.pdf
 Causes of changes in Aggregate
Demand
 Changes in the monetary policy
 Fluctuations in the exchange
rate
 Consumer confidence
 Changes in the economic conditions of other countries
 Fiscal policy
 Taxes and aggregate demand

12
 Demand side shocks
 Capital investment boom
 Rise or fall in the exchange rate
 Consumer boom abroad in the country of one of our major trading
partners

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 Computation of aggregate demand
 Formula: Aggregate Demand (AD) = C + I + G + (X-M)

Example

For the year 2007- 2008

 C = Rs 30 cores
 I = Rs 44 cores
 G = Rs 20 cores
 (X-M) = Rs -3 cores

Aggregate demand = 30 +44 + 20 +( - 3)

Aggregate demand = Rs 91 cores
GDP = 9.1 %

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 Explanation
 Till2006-07 the most contributing component in
aggregate demand was investments

 In 2007-08 along with investments the consumer

expenditure was also higher than previous years

 The external trade made negligible or negative

contribution.

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Difference between GDP and AD
 Aggregate demand curve explains the level of goods demanded at
each price level

 GDP is actual level of goods exchanged

 One is the curve, the other is the actual point of intersection

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Downward Sloping Demand Curve

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 Main Reasons behind the downward sloping
demand curve
 The Price Level and Consumption: The Wealth Effect

 The Price Level and Investment: The Interest Rate Effect

 The Price Level and Net Exports: The Exchange - Rate Effect

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 ●
A decrease in the price level makes consumers feel more wealthy,

The Wealth Effect ●

which in turn encourages them to spend more
This increase in consumer spending means larger quantities of
goods and services demanded

The Interest Rate A lower price level reduces the interest rate, which encourages
●

greater spending on investment goods

This increase in investment spending means a larger quantity of
Effect
●

goods and services demanded

The Exchange- When a fall in the price level causes INDIA’s interest rates to fall, the
●

real exchange rate depreciates, which stimulates U.S. net exports

The increase in net export spending means a larger quantity of goods
Rate Effect
●

and services demanded

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Shifts in Aggregate Demand Curve
&
factors causing the shift

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Shift in Aggregate Demand Curve

Price
Level

AD3 AD1 AD2

Real Right
GDP Left

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 Shift Arising from Consumption
 Exogenous factors affecting consumption
◦ Tax rates
◦ Incomes – short term and expected income over
lifetime
◦ Wage increases
◦ Wealth
 Property
 Shares
 Savings
 Bonds

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Shift Arising from Investment
 Spending on:
◦ Machinery
◦ Equipment
◦ Buildings
◦ Infrastructure

 Influenced by:
◦ Expected rates of return
◦ Interest rates
◦ Expectations of future
sales

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Shift Arising from Government
Purchase
Defence
Health
Social Welfare
Education
Foreign Aid
Regions
Industry
Law and Order

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 Shift Arising from Net exports
Recession
Movements in the
exchange Rate

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Shifts in the Aggregate Demand Curve: A Summary

Expansionary monetary policy Contractionary monetary policy

Ms AD curve shifts to the right Ms AD curve shifts to the left

Expansionary fiscal policy Contractionary fiscal policy

G AD curve shifts to the right G AD curve shifts to the left
T AD curve shifts to the right T AD curve shifts to the left

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Demand Scenario in the Indian
Economy

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 Recent trends in the Indian economy

Positive Features Negative Features

Higher Change in Demographic Growing Uneven

Growth Life style Changes Regional Sectoral
Inequality Growth

Signals Current Signal Potential

Demand Demand/Problems

Source: Macro-economic policy environment ; Shyamal Roy 28

 India: Sectoral share of GDP, 1990-91 to 2005-06
70.00%

60.00%

50.00%
Percentage of GDP

40.00%

30.00%

20.00%

10.00%

0.00%
1990- 1991- 1992- 1993- 1994- 1995- 1996- 1997- 1998- 1999- 2000- 2001- 2002- 2003- 2004- 2005-
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

Services share Industry Share Agriculture Share

Source: Macro-economic policy environment ; Shyamal Roy

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 India: GDP Growth, 1991-92 to 2005-06

9
8.51 8.43
8 7.84
7.34 7.53
7.25
7
6.51 6.36
6
%change per annum

5.9 5.79
5 5.12
4.79
4.37
4
3.77
3

2
1.3
1

0
1991- 1992- 1993- 1994- 1995- 1996- 1997- 1998- 1999- 2000- 2001- 2002- 2003- 2004- 2005-
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

Source: Macro-economic policy environment ; Shyamal Roy

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 India: Overall and Sectoral GDP growth, 1990-91
15.0 0 %
to 2005-06

10 .0 0 %
% per annum

5.0 0 %

0 .0 0 %
19 9 1- 19 9 2 - 19 9 3 - 19 9 4 - 19 9 5- 19 9 6 - 19 9 7- 19 9 8 - 19 9 9 - 2 0 0 0 - 2 0 0 1- 2 0 0 2 - 2 0 0 3 - 2 0 0 4 - 2 0 0 5-
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

-5.0 0 %

-10 .0 0 %
GDP Services Industry Agriculture

Source: Macro-economic policy environment ; Shyamal Roy

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 Disaggregated look
A disaggregated look , gives the following picture:
• Services sector (62%) has been impressive and largely
domestic demand driven
• Industry (19%), showed a sluggish growth rate but has since
revived.
• Agricultural sector (19%) continues to be random, depending
on weather

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 Analysis of growth
• Indian GDP growth has been largely propelled by the growth of
the service sector

• The service sector growth and, thus, the overall growth is

unsustainable unless the other two sectors of the economy also
register a higher growth

• Sustained growth in industry and a turnaround in agriculture is

constrained by lack of investment in infrastructure

• Investment in infrastructure, thus, holds the key to sustained

growth of GDP in India

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 State of the Indian economy today

Sector Share

Agriculture 19%

Industry 20%

Services 61%

All 100%

Source: Macro-economic policy environment ; Shyamal Roy

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Understanding the global
context

35
Global Economic Structure Today
• US, Japan and the
European region account
for more than 60% of
global GDP
• Substantial part of the
rest of the world’s GDP
growth is driven by what
happens in the above
countries
• India and China are
different

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 Global Economic Prospects
• US economic is on the path of recovery however, not without
certain concerns
• Europe and Japan still have some ways to go in terms of
sustained recovery
• China is doing well and is substituting US, Japan, and Europe, to
some extent, in terms of providing market for other country's
products
• India is the other country which is doing well and is attracting lot
of business interest from abroad

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 Special Cases of China and India

• Both are large economies with a large domestic market

• They are the fastest and second fastest growing
economies, respectively, in the world today
• Both have a huge potential for growth
• Both are attracting considerable investment interest from
abroad
• Both are capable of considerably tilting the balance
against excessive dependence on west, particularly, the
US

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 India: Problems and Prospects

• Structural rigidities, lack of infrastructural support

have been the key bottlenecks
• Coalition politics dictates the pace of change
• However, no policy uncertainty
• Substantial rise in investment in infrastructure which
is crowding in rather than crowding out private sector
investment
• Offers tremendous potential in knowledge based
industries

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 China: Problems and Prospects

• Financial Sector extremely fragile and highly

vulnerable
• Piracy rampant
• Structural rigidities
• Philosophical question remains as to how long a
communist government will be able to foster market
driven policies in the face of growing inequalities
• However, infrastructure highly developed
• Government hassles least

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 What’s in store for the future ?

• Global investment interests may shift towards

non- Japan Asia, including South Asia in the
short run
• US and some other countries may be tempted to
resort to protectionist measures
• The biggest threat to globalization and free trade
may come from return of protectionism
• Hopefully, long term considerations will
outweigh short term economic pressures

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 Bibliography
 http://www.cliffsnotes.com/study_guide/Aggregate-Demand-AD-C
urve.topicArticleId-9789,articleId-9737.html

 http://tutor2u.net/economics/revision-notes/as-macro-aggregate-de
mand.html\

 http://indiabudget.nic.in/

 http://indiabudget.nic.in/es2008-09/seconomy.htm

 Introductory Economic Theory, 7th edition

 Macroeconomic policy environment, Shyamal Roy

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