Change in Consumption

A change in consumption is caused by any of the following factors

  • Changes in income: Income increases consumption increases and vice versa.
  • Changes in interest rates: Fall in interest rates will make borrowing money cheaper. Consumers will now be tempted to take loans and purchase goods and services. Consumption will rise. On the other hand if the interest rates increase, borrowing becomes expensive. Consumers will be more tempted to save rather than spend. Consumption will fall.
  • Changes in wealth: A rise in house prices or the value of stock and shares makes a person feel wealthy. Consumers feel more confident and tend to spend more .
  • Changes in consumer confidence: Higher consumer confidence is likely lead to increased consumption.

Change in Investment

  • Interest Rates: If interest rates are low firms will find it easy to borrow funds for investment. Investment increase when interest rates fall.
  • Changes in National Income: If the national income increases, firms will have to invest further to increase output (induced investment).
  • Technological change: Regular changes in technological front demand firms to invest in order to keep up with the changes and remain competitive.
  • Business Confidence: The economic environment in an economy is a major factor in determining the investment level. When an economy is showing signs of healthy growth, firms will have positive expectation and will invest in expanding their facilities and to meet higher demands in the future. During troughs firms will be more conservative in their investments and thus AD will be affected.

Change in Government Expenditure

Government Expenditure depends on

  • Macroeconomics objectives: If the government is considering increasing employment then it might increase its spending on public projects.
  • Condition of the economy: During phases of slow economic growth, government is more likely to increase its spending in order to stimulate the economy.

Changes in net exports

Exports are domestic goods bought by foreigners. Exports will rise when

  • Foreigners income rise
  • Exchange rate of the exporting country is falling.
  • The economy follows a more liberal trade policy i.e. free trade increase
  • Inflation rate in the economy is comparatively lower than its trading partners.

Imports are the goods bought from foreign country. Imports will rise when

  • Domestic income rises. This is because people will increase their consumption and thus imports will increase.
  • Exchange rate of the importing country increase. Now it becomes cheaper for the country to purchase from outside as their currency is stronger than their trading partners.
  • If the economy is following a liberal trade policy i.e. free trade increases.
  • Inflation rate is high