Importance of aggregate demand
AGGREGATE expenditure is the total amount spent of the economy’s output by all households, firms, foreigners as well as the Government. The components of aggregate expenditure consist of household consumption, business investment, government purchase and net exports. When aggregate demand is less than aggregate output, inventories will increase and prices will fall. Firms will lower production and lay off workers to save on cost and lower price to sell off their inventory.
Total planned spending depends positively on the level of income and output in an economy. For two reasons, if households have more income they are likely to increase their spending on many goods and services. An increase in spending therefore increases the expenditure and therefore output. If the resulting aggregate output is less than potential output, then this will cause a recessionary gap), leading to a fall in employment and inflation. By contrast, when aggregate expenditure exceeds aggregate output, inventories fall, causing firms to hire more workers and to invest in other factors of production, such as land or machinery, to produce more. If aggregate expenditure exceeds the potential output of the economy, then firms will have to pay higher prices for its factors of production, including overtime to its workers, and pay higher variable costs when using existing facilities for longer time periods to increase production. This increased demand leads to an inflationary gap), which, in turn, increases prices sharply.
If households have high income. There are likely to increase their spending on many goods and services. The relationship between income and consumption is one of the corner stones of the macro economics. Firms are likely to decide that higher level of output mean that there should build up their capital stock and thus increase their investment. Below we will discuss why government transfers are not counted as part of the country’s GDP.
GDP is defined as total market value of all final goods and services produced within a country in a financial year. It can also be defined as the monetary measure of the market value of all final goods and services produced in a period of time and it’s often annually. GDP includes all private and public consumption, government outlays, investments, private inventories, paid in construction cost and the foreign balance of trade. GDP is a broad measurement of a nation’s overall economic activities it may be in contrast with Gross National Product, which measure the overall production of economy’s citizens including those living abroad, while domestic production by foreigners is excluded.
It is important to note that government transfers are not included as part of an economy’s GDP because transfer payments are made by the government as ‘one-way’ payment of money for which no goods, money or service is received in exchanged, hence they don’t form a part of GDP. Governments use such payments as a means of income redistribution (universal basic income) under social welfare schemes such as social security, old age or disability pensions, student grants and unemployment compensation. However the potential problem of expansionary fiscal policy is that it will lead to an increase in the size of government’s budget deficit.
Larger deficit could cause markets to fear debt default and push up interest rates on the government debt. Transfer payments are not included in GDP because there do include any income which is ‘not earned’ or for which a factor service has not been rendered for example old age pension received by the senior citizens is not earned income. It is just money transferred by the government without anything in return. Because GDP measures the value of domestically produced goods and services and with transfer payment you simply transfer income for example by taxing one person and giving a benefit to another you do not produce any new goods or services. GDP says nothing about the distribution of income.
In conclusion transfer payments are not incorporated in the Gross Domestic Product (GDP) because there have no goods and services produced in return.
◆ Blessing Nyatanga holds a Bachelor’s Degree in Banking and Investment Management from NUST.0784909184/ blessnyatanga@gmail.com