Why is aggregation important for macroeconomics

These are issues that are typically abstracted away from in both the measurement and analysis of national income and growth. This project will extend classical aggregation theorems that allow for non-linearities, distortions, heterogeneous agents, heterogeneous firms, production networks, and international trade further to environments with non-neoclassical, non-convex, and non-continuous production structures.

The project will apply the theoretical results to recently available micro-level datasets that can discipline and put structure on the rich range of theoretical possibilities.

Emmanuel Farhi , Principal Investigator. David Baqaee , Co-Principal Investigator. Aggregate demand consists of all consumer goods, capital goods factories and equipment , exports, imports, and government spending programs.

The variables are all considered equal as long as they trade at the same market value. While aggregate demand is helpful in determining the overall strength of consumers and businesses in an economy, it does have limits.

Since aggregate demand is measured by market values, it only represents total output at a given price level and does not necessarily represent the quality of life or standard of living in a society.

Also, aggregate demand measures many different economic transactions between millions of individuals and for different purposes. As a result, it can become difficult to determine the causality of demand and run a regression analysis, which is used to determine how many variables or factors influence demand and to what extent.

If you were to represent aggregate demand graphically, the aggregate amount of goods and services demanded would be placed on the horizontal X-axis, and the overall price level of the entire basket of goods and services would be represented on the vertical Y-axis. The aggregate demand curve, like most typical demand curves , slopes downward from left to right. Demand increases or decreases along the curve as prices for goods and services either increase or decrease.

Also, the curve can shift due to changes in the money supply , or increases and decreases in tax rates. The equation for aggregate demand adds the amount of consumer spending, private investment, government spending, and the net of exports and imports. The formula is shown as follows:. A variety of economic factors can affect the aggregate demand in an economy. Key ones include:. Economic conditions can impact aggregate demand whether those conditions originated domestically or internationally.

The financial crisis of , sparked by massive amounts of mortgage loan defaults, and the ensuing Great Recession , offer a good example of a decline in aggregate demand due to economic conditions. The crises had a severe impact on banks and financial institutions.

As a result, they reported widespread financial losses leading to a contraction in lending, as shown in the graph on the left below. With less lending in the economy, business spending and investment declined. From the graph on the right, we can see a significant drop in spending on physical structures such as factories as well as equipment and software throughout and With businesses suffering from less access to capital and fewer sales, they began to lay off workers.

The graph on the left shows the spike in unemployment that occurred during the recession. Simultaneously, GDP growth also contracted in and in , which means that the total production in the economy contracted during that period. The result of a poor-performing economy and rising unemployment was a decline in personal consumption or consumer spending—highlighted in the graph on the left. Personal savings also surged as consumers held onto cash due to an uncertain future and instability in the banking system.

We can see that the economic conditions that played out in and the years to follow lead to less aggregate demand by consumers and businesses. Aggregate demand definitely declined in and However, there is much debate among economists as to whether aggregate demand slowed, leading to lower growth or GDP contracted, leading to less aggregate demand. Whether demand leads to growth or vice versa is economists' version of the age-old question of what came first—the chicken or the egg.

Boosting aggregate demand also boosts the size of the economy regarding measured GDP. However, this does not prove that an increase in aggregate demand creates economic growth. Since GDP and aggregate demand share the same calculation, it only indicates that they increase concurrently. The equation does not show which is the cause and which is the effect. The relationship between growth and aggregate demand has been the subject of major debates in economic theory for many years.

Early economic theories hypothesized that production is the source of demand. The 18th-century French classical liberal economist Jean-Baptiste Say stated that consumption is limited to productive capacity and that social demands are essentially limitless, a theory referred to as Say's Law of Markets. Say's law, the basis of supply-side economics , ruled until the s and the advent of the theories of British economist John Maynard Keynes.

By arguing that demand drives supply, Keynes placed total demand in the driver's seat. Keynesian macroeconomists have since believed that stimulating aggregate demand will increase real future output. According to their demand-side theory, the total level of output in the economy is driven by the demand for goods and services and propelled by money spent on those goods and services.

In other words, producers look to rising levels of spending as an indication to increase production. Keynes considered unemployment to be a byproduct of insufficient aggregate demand because wage levels would not adjust downward fast enough to compensate for reduced spending. Some of the questions you will explore are: What does the macro economy look like in the short run? What does it look like over the long run? What determines the amount of total spending in the economy?

What determines the amount of real GDP? How do the level of GDP and the price level respond to shocks i.