Greetings, traders, and welcome back.
Thank you for joining me again
as always. Chris here, bringing you another Survival Guide.
Today's subject will be aggregate demand.
We're going to talk about exactly what aggregate demand is,
as well as work our way into the aggregate demand curve, and
we'll talk about the factors that influence the shifts in that particular curve.
This is one of those fundamentally driven aspects, so it's
not going to be indicator-based, but that doesn't mean that this information
can't potentially help you as you are attempting to pass the Gauntlet Mini,
so make sure you pay attention, take some notes, and enjoy the ride.
But without further ado, let's get going.
At one point or another, you may have heard of aggregate demand,
or aggregate demand curve, but maybe didn't have the willpower
to dive deeper by yourself.
Well, today, I'm going to make it easy on you.
I'm going to sum up exactly what aggregate demand and the aggregate demand curve
is, that way, you have what you need to know, and you don't
have to put in all of that tedious work on your own.
And the reason is I feel that those who haven't actually looked
at an aggregate demand curve might assume that it's just simply a straight line.
I find that many traders believe that, as the average price
comes down, the demand increases. This assumes a whole array
of different factors will remain constant, which, in reality,
they don't. Things such as consumer spending, private investments,
government spending, exports, and a variety of other things
that we're going to cover, all are things that need to be taken into consideration
when analyzing these types of scenarios, and any well-rounded
trader should be aware of these type of fundamentals as well.
So, first things first: What is aggregate demand?
The definition of aggregate demand is relatively simple to understand.
It's an economic measurement that reflects total demand for all
finished goods and services produced in an economy and listed in local currency.
There is a direct correlation between aggregate demand and gross domestic
product, even though they are not the exact same thing.
The gross domestic product reflects the total amount of goods and services
produced in an economy in the local currency, but adjusted for inflation.
Changes in interest rates, consumer demand, and other factors
will shift the curve to the left or to the right.
There is an ongoing argument amongst economists as to whether an increase
in consumer demand prompts an increase in production.
It could also be that an increase in production prompts an increase
in demand. Which came first, the chicken or the egg?
That's the idea here.
To better understand the aggregate demand, we should talk
about the impacting factors behind it, and contrary to popular
belief, changes in the aggregate demand are not caused
by the change in the price of individual products or services.
It's actually more of a shift in economic activity. An example
of this is in recessionary times, we tend to see a reduction in
consumer spending. It's also accompanied by an increase in
savings and a reduction in debt levels.
This prompts a downward shift in the aggregate demand curve,
and as a consequence, demand for products and services will fall.
In response, the need to save costs can potentially lead to large numbers
of layoffs, and large-scale unemployment can prompt another fall in consumer
demand, creating something of a vicious cycle.
And this is why we tend to see an increase in government spending
and tax breaks in recessionary time.
It's meant to compensate for the reduction and other determinants
of aggregate demand. We're seeing a lot of this going on right now with
the coronavirus, with various things that the government has been employing.
In buoyant economies, there is reduced requirement for government investment.
Tax breaks and growing wages feed into growing consumer demand,
as well as an upshift in general demand for goods and services.
Growing demand for goods and services tends to result in specific upward
pricing pressure. A growing economy often leads to higher
average wage increases. When that happens, it prompts an increase
in overall business costs. The resulting higher inflation puts further upward
pressure on elements such as material costs, and as we mentioned,
there's often a lag between the increase in the cost of goods and services
to consumers and the cost of business itself.
It can be tempting to directly associate a graph showing
the aggregate demand curve with a simple supply-demand formula
for an individual product or service, but in this scenario, the assumption is that
the price of all goods and services remains constant, as does the income
and expenditure of consumers. When looking at an aggregate demand
curve, it is various determinants that we need to take into account
with a whole range of factors. If, for example, we look at interest rates,
they can have a huge impact on business costs and consumer demand.
If interest rates increase, then this will push the cost of business borrowing
and consumer loans higher naturally, which prompts a reduced demand.
A reduction in interest rates will have the opposite effect.
It reduces the cost of borrowing, encouraging business investment
and boosting overall consumer demand. There is an undeniable correlation
between changes in interest rates and the cost of business borrowing
with consumer credit. It is worth noting that speculation is also heavily
factored into influencing this demand. If, for example, a buoyant economy
has many consumers and businesses, assuming that the strength of that
economy is going to continue forward, they may continue to encourage it to
go forward. Determining prices based on that premise could result
in higher costs of goods for both businesses and the consumers.
This may impact the short-term demand, which could then, in turn, lead
to a rise in the aggregate demand. Conversely, when we look at what
we're experiencing now in light of the coronavirus pandemic,
there could be an assumption that the economic activity would reduce,
and prices will fall in real terms. This scenario would prompt
a reduction in aggregate demand and shift the curve to the left.
Aside from interest rates and inflation like we mentioned, there are other
leading factors that impact aggregate demand, as well as the aggregate
demand curve, so we're going to go over exactly what those are.
The first one is the household wealth. With household wealth,
this means that when we're looking at economic data, we can come
across the average household wealth and disposable income,
and when we do this, an increase in the household wealth, when we
pay attention to that, it generally has a positive impact on aggregate demand.
This is mainly because of greater confidence in the economy, high
levels of disposable income, and more willingness to take on consumer debt.
When the household wealth declines, we will then experience a reduction
in consumer debt. And this is due to an increase in consumer savings and
a delay/postponement in acquiring certain types of goods and services.
This has a detrimental impact on the aggregate demand curve
on the opposite side of the coin. Then, we have the government expenditure.
You will notice that governments tend to inject greater levels of capital into
the economy in more challenging times, like now. This could take the shape of
increased investment in housing, reduction in business rates,
or even income tax. The idea is simple: When you reduce living expenses or
business costs, you help build consumer disposable income. Doing so reduces
the downward impact on aggregate demand. Consequently, in more
buoyant and economic times, the government tends to refrain from tax
giveaways and huge consumer investments. The reason being,
it could create an overheating economy and a consumer bubble
that may be ready to burst. Then we have Foreign Exchange rates.
Currencies very rarely move in the same direction, and as a consequence,
the cost of goods to foreign buyers tends to be fairly volatile
across different settings. The formula for calculating aggregate demand
does take net exports into account, therefore, changes in the value of
Foreign Exchange currencies themselves can have an impact
on the aggregate demand curve. If, for example, the British pound is
weakening against the US dollar, then US consumers would be more attracted
to UK imports. And on the flip side, if the pound is strengthening against
the US dollar, that would make US imports more attractive to UK buyers.
And finally, we have cost of materials. Moving on from the currency exchange
rates, let's talk about the imports themselves. Many businesses rely
on the imports of materials or even employees, to be able to
provide those products and services that they need to for their business.
For example, the cost of oil is traditionally quoted in US dollars,
therefore, any movement in the pound- dollar exchange rate would have an
impact on the base business costs in both countries. We also need to take
into account the fact that some materials may become scarce
in times of heightened demand. On a purely supply-demand basis,
this can often lead to an increase in the cost of materials.
Using a graph, we can take a look at exactly what the curve looks like.
And we're also going to switch over to this image here, that way you can
look back and forth between a regular curve and how the curve shifts.
So, with this image here, with this graph, we can see that the curve is skewed
towards an increase in aggregate demand as price levels fall.
However, it's not a straight line. The impact certain factors have,
such as interest rate changes, can distort the curve.
This also doesn't show any up or downwards shifts in the curves.
Now, as we switch over to what causes the graph to shift, we can see exactly
what an upshift in economic activity would do to the graph,
expanding the curve outward.
The formula that we use to calculate the aggregate demand is based
on an economic model that was presented by Robert Mundell
and Marcus Fleming, and here it sits. This is a very simple formula
to follow because it is literally all addition.
Now, it's commonly referred to as the Mundell-Fleming Model.
There is a much more complex formula which involves the individual calculations
for the C, I, G, as well as the Nx, but in this situation, our aggregate
demand is going to be our AD, and this is equal to our C plus our I,
plus our G, plus our Nx. And our C is our consumer spending,
our I is going to be our business investment spending on non-final
capital goods, our G is going to be our government investment
expenditure on public goods and social services, and our Nx
is just going to be equal to our net exports.
Now, for some frequently asked questions, so maybe I can save
you a trip to the old Google machine.
Number one is going to be: How can government policies shift
the aggregate demand curve to the right?
Well, there's numerous ways in which government policies
can shift the aggregate demand curve to the right, and those include
maintaining relatively low interest rates, or reducing tax burden,
or working towards full-time employment and encouraging exports.
There's a ton of different ways, but those are some of the most common.
Full employment equates to more disposable income, while low
interest and tax rates ensure that consumers retain a larger share
of their income and business costs remain relatively low. Historically,
interest rates have been used as the tool of choice by many central banks
and governments, although disinvestment and investment strategies in the economy
can also have a similar impact. Number two is going to be:
Why does aggregate demand slope downward?
Many people might automatically assume that the aggregate demand
curve should be a straight line, but this would assume that all determinants
remain constant, like we said. This is not always the case.
Even if the determinants were to move in the same direction, they wouldn't
necessarily move at the same rate. There's also the added impact of
imports and exports and the lag between the increase in demand
and the increase in production cost, so when you look at it from a distance,
the aggregate demand downward slope reflects the actual situation
as opposed to the theoretical situation.
And for number three: Which combination of factors would most likely increase
aggregate demand? Well, the basic idea is that any factor
which would increase consumer spending would also lead to an
increase in aggregate demand. And some of the more influential factors 0:13:14.310,1193:02:47.295 increase in aggregate consumer spending would also lead to an
are the relatively low interest rate ideas, or reducing borrowing costs
for businesses and consumers, or reduction in direct taxes like income tax.
The impact of these factors would depend on the impact of other factors,
which could reduce disposable income or induce a degree of concern amongst
consumers. It's also worth remembering that changing the direction of the
aggregate demand is not something that happens overnight.
We have seen some brief and sharp shifts that occurred, such as the
housing market collapse around 2009, but the 2020 coronavirus pandemic
that we're currently experiencing is already causing a sharp shift as well.
But once again, this is something that is generally not the case.
These things usually take time.
So, in conclusion, aggregate supply, as well as the aggregate supply curve,
is a very useful piece of information for anybody looking to do fundamental
analysis and trading over the long term.
It's different than regular supply and demand due to the fact that it has
a dynamic range of different variables that are all moving at different rates.
So, when someone considers it the same as a supply and demand chart,
that's really a strong oversimplification.
But other than that, when you're trading the Gauntlet Mini, you might find
that technical analysis may be what you are favoring in the short term,
but the idea of the Gauntlet is to come out a successful trader and remain a
successful trader for the long term, so this knowledge is crucial in the long term.
I thank you for joining me as always, folks. I hope you have a good rest of
your day and good luck in the markets.
Please make sure you hit that subscribe and like button down below
because it helps me out a great deal. Best of luck everybody. Over and out.