Introduction to the demand side of the economy

Reading: AB, chapter 4, section 1.

Overview

Our discussion so far of the labor market and the production function represents the supply-side of the economy independent of the overall level of aggregate demand. Changes in factors that affect labor demand (N^d), labor supply (N^s) and the production function (F) change the potential supply, Y*, of the economy independent of demand. (Note: variables with supercript "*" are equilibrium values.)

The demand-side of the economy focuses on the aggregate demand for goods and services independent of potential supply. To simplify our analysis, we assume that there is no foreign sector to the economy. Then aggregate demand for goods and services, using the expenditure approach, is defined as: Y^d = C^d + I^d + G₀, where C^d = demand for consumption goods, I^d = demand for investment goods and G₀ = exogenous government spending on goods and services. Here, NX = 0 since there is no foreign sector. Modeling the aggregate demand for goods and services thus requires modeling the demand for consumption goods and the demand for investment goods. However, since desired national saving is defined as S^d = Y^d - C^d - G₀ we may also focus on modeling saving behavior instead of consumption behavior.