Aggregate demand does not include imports.

Introduction

Aggregate demand is the total demand for the goods and services produced in the economy over a period of time and is comprised of consumption expenditure, investment expenditure, government expenditure on goods and services and net exports. Imports are foreign goods and services which are produced in other economies.

Many students think that aggregate demand includes imports. The Principal Economics Tutor will discuss this economic misconception in economics tuition with the students.

Exposition

As aggregate demand refers to the total demand for the goods and services produced in the economy, it does not include imports. However, the components of aggregate demand which are consumption expenditure, investment expenditure, government expenditure on goods and services and exports include imports. Therefore, to derive aggregate demand, imports are subtracted from consumption expenditure, investment expenditure, government expenditure on goods and services and exports.

AD = C + I + G + (X โ€“ M)

In the above function, aggregate demand (AD) is the sum of consumption expenditure (C), investment expenditure (I), government expenditure on goods and services (G) and exports minus imports (M). Exports minus imports are commonly referred to as net exports (X โ€“ M).

In order to have a better understanding of aggregate demand, consider the following function.

AD = CD + ID  + GD + XD

In the above function, aggregate demand (AD) is the sum of consumption expenditure on domestic goods and services (CD), investment expenditure on domestic goods (ID), government expenditure on domestic goods and services (GD) and exports of domestic goods and services (XD).

M = CM + IM + GM + XM

In the above function, imports (M) are the sum of consumption expenditure on imports (CM), investment expenditure on imports (IM), government expenditure on imports (GM) and exports of imports (XM) which are commonly referred to as re-exports.

Adding (CM + IM + GM + XM) to and subtracting (M) from (CD + ID  + GD + XD) yields the following function.

AD = CD + CM + ID  + IM + GD + GM + XD + XM โ€“ M

Replacing (CD + CM) with (C), (ID  + IM) with (I), (GD + GM) with (G) and (XD + XM) with X yields the aggregate demand (AD) function.

AD = C + I + G + (X โ€“ M)

Therefore, students should not think that aggregate demand (AD) includes imports simply because imports appear in the aggregate demand (AD) function.

To understand it aggregate demand (AD) in a simpler way, we can assume that only households import goods and services which is a standard assumption made in economic textbooks for simplicity.

AD = C + I + G + (X โ€“ M)

AD = (CD + M) + I  + G + (X โ€“ M)

AD = CD + I  + G + X

In the above function, aggregate demand (AD) is the sum of consumption expenditure on domestic goods and services (CD), investment expenditure (I), government expenditure on goods and services (G) and exports (X).

 

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