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Understanding Aggregate Demand and Consumer Confidence

written by: •edited by: Elizabeth Wistrom•updated: 4/8/2010

What is aggregate demand and how does it affect the average consumer? Here, we’ll explore this issue to better understand aggregate demand and consumer confidence.

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    What Is Aggregate Demand?

    According to the Business Dictionary, aggregate demand is the “level of demand for desired good and services within a national economy." In the US, aggregate demand is utilized to configure the gross domestic product or GDP. Factors that influence aggregate demand and the GDP include consumer spending, stocks, bonds, investing trends, and government spending.

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    How Does Consumer Confidence Affect Aggregate Demand?

    Australia Inflation Wikimedia Commons Economic experts say consumer confidence makes up approximately two-thirds of the aggregate demand based on income levels or changes, buying and spending trends, and economic conditions. A family’s disposable income can increase or decrease aggregate demand. Disposable income is considered what a family has left after normal cost of living expenses are paid.

    When an economy falls and job losses or decreases in salaries occur, families have less disposable income. Depending where a family falls in income loss is also important. Even in economic downturns those on the higher end of the wage scale habitually spend less of their disposable income. Those on the lower end will spend the same or more of their disposable income when the economy is down.

    Consumer trust is often the largest factor in a down economy. Households look for lower prices and discounts and may wave a favorite brand for a cheaper brand. Because most families don’t include economic experts, that trust factor plays a huge role when families consider stock market drops, the possibility they will lose their job, and if they will have enough money to pay their mortgage and other living expenses.

    In good economic times aggregate demand goes up based on consumer spending. Supply and demand is high because of increases in spending habits. On the other end of that scale, when the economy is bad and demand is lowered, suppliers may charge higher prices for a product that was cheaper in good economic times.

    Photo Credit: Australia Inflation Wikimedia Commons

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    Consumer Confidence Index

    The Consumer Confidence Index or CCI is determined by consumer spending habits and an analysis of a sampling of 5,000 households each month.

    Trends in the CCI vary from month to month and year to year. In a failing economy brand loyalty is tested and big businesses stretch advertising budgets to the max to hopefully keep customers interested in their products. Competition in product pricing and availability increases when consumer favorite brands fall behind in sales. Holiday and vacation spending is more wisely budgeted by consumers and often the first choice becomes an impossible choice.

    On the other side, big businesses adjust products and services based on the CCI and aggregate demand. They do this by lowering prices in a range of products or services. The product or service may be smaller or lowered but the opportunity is not lost through innovative advertising. To the average consumer, if a product or service appears to be a deal, they will purchase it.

    Federal, state, and county governments affect consumer confidence and can cause aggregate demand to rise or fall. When property taxes rise, consumer confidence is lowered. When new or in-place federal or state programs call for increased sales and income taxes from citizens, consumer confidence is lowered. Moreover, if a government organization can balance a budget without increasing consumer money, confidence remains high.

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    While the calculations and data analysis for consumer confidence is based on many factors, it does affect aggregate demand in terms of consumer spending, product and service decisions, and government and brand loyalty. In other words, the aggregate demand depends upon consumer confidence; it is how it is determined. Understanding aggregate demand and consumer confidence also helps to predict trends, especially consumer trends that in turn affect big business and governments.