Explain the factors affecting Aggregate Demand (AD), given the context of Singapore. [10]

This economics paper explains the factors affecting Aggregate Demand (AD) and Aggregate Supply (AS), given the context of Singapore. 

First and foremost, in economic theory, AD and AS represent the aggregate demand (AD) and supply (AS) respectively of all the goods and services in an economy. The level of real national output and the general price level are determined by the intersection of AD and AS on an AD-AS diagram.

THINK: how would you draw an AD-AS diagram to reflect the intersection of AD and AS?

In theory, AD refers to an economy’s total demand for domestically produced goods and services for a given general price level. AD = C + I + G + (X – M), where C represents consumption, I represents investment, G represents government expenditure, X represents exports, M represents imports, and (X – M) represents net exports. Real national output (or real national income) and the general price level is determined by the intersection of the AD and AS curves. The AD curve is downward sloping because the lower the general price level, the greater the quantity demanded for domestic outputs. As AD = C + I + G + (X – M), what affects the AD curve are the factors that influence each individual component, which are C, I, G and (X – M). An increase in any of these components of AD would shift the AD curve to the right, while a decrease would shift the AD curve to the left.

Consumption

First, consumption (C) refers to household’s expenditures on goods and services. Consumption is affected most by income and wealth. For instance, when the Singapore economy is booming, rising wages of workers, rentals of buildings and assets, company profits, and interest will raise households’ incomes, which will then in turn increase consumption. On the other hand, higher personal income taxes and increased social security contributions, for instance in Singapore’s case particularly such as increases in the amount in the Ordinary Account of the Central Provident Fund (CPF) that Singaporean workers have to set aside for their retirement, will lower disposable income, thus dampening consumption. Wealth consists of savings and assets. A booming Singapore stock or property market pushes the value of financial and property assets up, thus making household feel that they are wealthier, which would then cause them to consume more, thus in turn increasing the consumption level. Conversely, if the Singapore stock or property market faces a downturn, Singaporean households will feel that they are less wealthy, and thus they will consume less, thus in turn causing consumption to decrease. As wealth also consists of savings, it is thus also affected by taxes such as property taxes and capital gains taxes; however, in the case of Singapore there are no capital gains taxes. The higher these taxes are, the lower the consumption level will be. Since AD = C + I + G + (X – M), a rise in consumption will increase AD thus shifting the AD curve to the right, a drop in consumption will decrease AD, thus shifting the AD curve to the left.

Investment

Second, investment (I) refers to firms’ spending on capital goods. Investment is affected most by business expectations. For example, if a Singapore firm expects the demand for its goods to rise, it is likely that the firm would invest more currently in machinery and plant to boost its future capacity. This would thus increase the investment level in Singapore, and since AD = C + I + G + (X – M), a rise in investment would increase AD, and shift the AD curve to the right, whilst on the other hand a drop in investment would decrease AD, thus shifting it to the left.

Government expenditure or government spending

Third, government expenditure (G) refers to the government’s spending on publicly provided goods and services. Government expenditure consists of government spending on public goods and services and also on government investment in infrastructure; the amount that the Singapore government spends depends on the state of the economy, as well as the aims and objectives of the government in power. In this case, let us focus on government expenditure in general, for instance spending on teachers’ salaries and on the Singapore Armed Forces, rather than government investment. Since AD = C + I + G + (X – M), a rise in government expenditure would cause a rise in AD, thus shifting the AD curve to the right, whilst conversely, a drop in government expenditure will cause a drop in AD, thus the AD curve will shift to the left.

Net exports

Fourth, exports (X) refer to foreign purchases of domestically produced goods and services while imports (M) refer to domestic purchases of foreign produced goods and services. (X-M) forms the net exports of a country, which in Singapore’s case is very important given that Singapore is a small and open economy. Factors which affect exports and imports are the usual factors which affect demand and supply, such as tastes and preferences, disposable incomes of foreigners who purchase these goods, and prices of related goods to these exports, such as substitutes and complements. Exports may rise due to foreigners developing a preference for Singapore’s exports, possibly due to better marketing or better quality of goods produced. On the other hand, if other countries promote their products more, or have better or new products compared to Singapore, then Singapore will be expected to face rising demand for imports. Since AD = C + I + G + (X – M), a rise in exports would increase AD thus shift the AD curve to the right, if there is a drop in exports, the AD curve will shift to the left as AD decreases. A rise in imports would also cause a drop in AD, thus shifting the AD curve to the left, while a drop in imports would cause an increase in AD, thus shift the AD curve to the right.

  

In conclusion, the factors that affect Singapore’s AD are the factors which affect consumption, investment, government expenditure, and net exports. 

JC Economics Essays - This is a modified economics essay written by student JQ, which was originally written under timed conditions for an economics test. Do remember that it is very important to time yourself whilst practising for the economics essay examination, because you have to craft a well-written economics paper within a given time limit. When practising for any economics test, you could plan a structure or outline for 5 minutes, and then spend the rest of the time crafting your response. Do note that this economics paper has been cleaned up for spelling, grammar, and also for essay structure, and some of his arguments have been repositioned for easier flow. Do you find that this economics paper is easy to read and clear cut? How has the clear and direct structure made it easier for you to read this paper? In addition to these two basic questions on essay structure, when reading this economics essay, the other questions that you could ask yourself are: (1) how would you approach this essay? (2) What economics knowledge or information do you need to answer this essay question properly? (3) Also, should a diagram be drawn? Why or why not? (4) Did the writer of the essay answer the question adequately, not just in theory but also in bringing in the Singapore context? Do remember to read with a questioning mind when thinking through this essay. Thanks for reading and cheers. 

Economics Quotes from Famous Economists

Here are some of my favourite economics quotes from famous economists, as well as famous, popular economics quotes:

Adam Smith

It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.

The Wealth of Nations (1776)

By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good.

The Wealth of Nations (1776)

Friedrich Hayek:

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design. To the naive mind that can conceive of order only as the product of deliberate arrangement, it may seem absurd that in complex conditions order, and adaptation to the unknown, can be achieved more effectively by decentralizing decisions and that a division of authority will actually extend the possibility of overall order.

The Fatal Conceit : The Errors of Socialism (1988)

Ludwig von Mises:

The capitalist system of production is an economic democracy in which every penny gives a right to vote. The consumers are the sovereign people. The capitalists, the entrepreneurs, and the farmers are the people’s mandatories. If they do not obey, if they fail to produce, at the lowest possible cost, what the consumers are asking for, they lose their office. Their task is service to the consumer. Profit and loss are the instruments by means of which the consumers keep a tight rein on all business activities.

John Maynard Keynes:

The long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again. (1923)

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.

Lord Lionel Robbins:

Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.

Milton Friedman:

Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.

I think the government solution to a problem is usually as bad as the problem and very often makes the problem worse.

One of the great mistakes is to judge policies and programs by their intentions rather than their results.

The ultimate goal of a positive science is the development of a "theory" or, "hypothesis" that yields valid and meaningful (i.e., not truistic) predictions about phenomena not yet observed.

Consider the problem of predicting the shots made by an expert billiard player. It seems not at all unreasonable that excellent predictions would be yielded by the hypothesis that the billiard player made his shots as if he knew the complicated mathematical formulas that would give the optimum directions of travel, could estimate accurately by eye the angles, etc., describing the location of the balls, could make lightning calculations from the formulas, and could then make the balls travel in the direction indicated by the formulas. Our confidence in this hypothesis is not based on the belief that billiard players, even expert ones, can or do go through the process described; it derives rather from the belief that, unless in some way or other they were capable of reaching essentially the same result, they would not in fact be expert billiard players.

JC Economics Essays - H1, H2, H3 A level Economics essays and economics tutorial materials. Economics quotes from famous economists can be used in H3 economics essays.