How do the main components of aggregate demand contribute to GDP growth

Waleed Wisal
How do the main components of aggregate demand contribute to GDP GROWTH?

The economic prosperity of a nation is conceded with the aggregate demand. According to economists, the higher the period of aggregate demand higher the economic prosperity can be perceived in a nation. On other hand, lowering the phase of aggregate demand would lead to perceiving economic crises. Aggregate demand contributes significantly to the GDP growth of any nation around the globe. Aggregate demand is composed of four components, in a short version, these components are known as the composition of CIGX.

Thus, researchers draw an equation of the aggregate demand which looks like

AD = C + I + G + X

It’s an abbreviation where C represents Composition, I for Investment, G for Government expenditure, and X for Net Exports. These four are the main components of aggregate demand that contribute to the GDP growth of any nation around the globe.

Now it’s important to understand each of the four components of aggregate demand and the way they contribute to GDP growth. The very first of these four components is consumption expenditure. It is the demand that has been driven by the local or domestic consumers. Researchers have also quoted it as “demand created by domestic consumers”.

Another significant demand is created by the producers or manufacturers. Because, for manufacturing goods and providing services, they require raw materials, machinery, and a workforce. Economists have named it, investment expenditure which is represented by ‘I’ in the equation of AD = C + I + G + X. Investment expenditure is also named by the researchers as “demand created by producers or manufacturers”. The third component of aggregate demand is government expenditure (G).

Government creates a significant demand that can influence the growth of the GDP of an economy. While the last component of the aggregate demand is X which is Net Exports. It is derived from the demand that has been created by the citizens of other than the parent country (foreigners). Not all products or services can be produced in a single country, if an economy tries to do, there would surely be a clear gap in the cost of manufacturing goods or services. Therefore, consumers look for better availability to get their goods and services, and thus demand created by foreigners plays a significant role in an economy as a strong component of the aggregate demand and one of the significant variables of GDP growth.

Elements of the aggregate demand that caused the global economic recession during COVID19

The highly contagious pandemics require social distancing and lockdown situations. COVID-19 is declared by the world health organization as one of the highly contagious viruses. Thus, there has been a complete lockdown, and somehow a curfew-like situation at some places around the globe. As result, the declining graph of the Aggregate Demand (AD) in all economies has been observed since the epidemic of COVID-19 and all its associated variants that eventually become a significant reason for the global economic recession.

Studying each component of the aggregate demand, consumption was the first component that was influenced the most by the outbreak of COVID-19. It declined mainly because of 2 reasons. The first reason for the decline in consumption was the people who were, and still are, afraid to go out to the market to purchase goods or services. As the fear of the chances of contracting the infection was high. The second reason was the decline in the personal income level of consumers with the shutting down of the factories and businesses in which they affiliated as employees or employers. The fear of going out of home, unemployment, and reduced income are considered significant elements of dampening the consumption expenditure (C) in the economy around the globe.

COVID-19 epidemic was declared a pandemic by WHO. Thus, it was no more an issue of one country or region. The whole world was affected by the outbreak. Therefore, it significantly influenced the net exports (X). A significant decline in purchasing power was seen universally. It was mainly due to the lockdown and government policies restricting the epidemic.

Consumption expenditure (C) and net export (X), both are positively correlated to Investment Expenditure (I). As investment is attached to better opportunities and attracted by the good rate of return. Because of the reduced demand of domestic as well as foreign consumers, investment was also found on the declining track. Because there was less demand for the majority of the goods and services in both domestic as well as foreign markets. Which compacted the willingness of the producers and manufacturers to invest.

However, only one out of the four components of aggregate demand was found to show a bit upward trend during such times. That is none else but government expenditures (G). Unfortunately, this upward trend was mainly found in the public health sector and transfer of payment as freebies to the poor sector of an economy. According to the practitioners, such an increase in government expenditure does not drive or increase the aggregate demand or the growth of an economy. As it is more in form of an expense or burden to overcome aftershocks of the losses to the overall economy.

Conclusion

Hence, during the COVID-19 pandemic, all four components of AD i.e. consumption (C), investment (I), government expenditure (G), and net export (X) found a declining trend. Thus epidemic has played a significant part in down-trending the components of AD and led to a global economic recession.

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