Edexcel A-Level Economics A (9EC0) · Theme 2
Specification points
- The components of aggregate demand (AD) and the AD curve.
- The factors that shift AD.
- The multiplier process.
Aggregate demand
Aggregate demand (AD) is total planned spending in an economy at each price level:
AD = C + I + G + (X − M)
The AD curve slopes downwards because a higher price level reduces real wealth, raises interest rates and makes exports less competitive. Consumption (C) is usually the largest component.
Components and their determinants
- Consumption (C) — income, interest rates, consumer confidence, wealth.
- Investment (I) — interest rates, business confidence ("animal spirits"), profits, technology.
- Government spending (G) — set by fiscal policy.
- Net exports (X − M) — exchange rate, world incomes, relative competitiveness.
Key definitions
| Term | Definition |
|---|---|
| Aggregate demand | Total planned spending in an economy at each price level. |
| Marginal propensity to consume (MPC) | The fraction of extra income that is spent. |
| Multiplier | The ratio of the final change in real income to the initial change in spending. |
The multiplier
An initial injection of spending circulates through the economy, creating further income and spending, so real output rises by *more* than the initial amount.
Multiplier = 1 ÷ (1 − MPC) = 1 ÷ MPW
The larger the marginal propensity to consume (and the smaller the withdrawals — saving, tax, imports), the larger the multiplier.
Worked example
A government invests £10bn in infrastructure. If the MPC is 0.8, the multiplier is 1 ÷ (1 − 0.8) = 5, so real income could eventually rise by up to £50bn — though leakages and limited spare capacity may reduce the effect in practice.
Common exam mistakes
- Omitting a component of AD or double-counting.
- Confusing a movement along AD (price level) with a shift (a component change).
- Calculating the multiplier from the wrong propensity.
Exam technique
Identify which component shifts AD and why, then use the multiplier to judge the *scale* of the effect. Evaluate using the size of the multiplier and spare capacity.
Quick revision
- AD = C + I + G + (X − M).
- Multiplier = 1 ÷ (1 − MPC).
- Larger MPC and smaller leakages → larger multiplier.