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PHYSICAL WEALTH, AGGREGATE DEMAND DETERMINANT:

One of several specific aggregate demand determinants assumed constant when the aggregate demand curve is constructed, and that shifts the aggregate demand curve when it changes. An increase in the physical wealth causes a decrease (leftward shift) of the aggregate curve. A decrease in the physical wealth causes an increase (rightward shift) of the aggregate curve. Other notable aggregate demand determinants include interest rates, federal deficit, inflationary expectations, and the money supply.
Household wealth comes in two basic forms--physical wealth and financial wealth. Physical wealth consists of houses, cars, land, property, furniture, appliances, and the whole array of satisfaction-generating physical goods. Financial wealth includes money, bank accounts, stock certificates, bonds, and other financial instruments that provide direct or indirect claims on physical goods.

With physical wealth the points is that once it has been acquired, it is no longer needed. That is, once Duncan Thurly owns a refrigerator, he has a refrigerator, and he does not need a refrigerator. Alternatively, not owning a refrigerator puts Duncan in prime position to buy a refrigerator. Changes in physical wealth, as such, tend to cause consumption expenditures to change in the opposite direction. If households have more physical wealth, then they do not need to buy what they have, and consumption tends to fall. If households have less physical wealth, then they do need to buy some, and consumption tends to rise.

A change in the physical wealth, by changing consumption expenditures, induces changes in aggregate demand. An increase in physical wealth decreases aggregate demand and a decrease in physical wealth increases aggregate demand.

Shifting the Curve
Shifting the Curve

The exhibit to the right presents a common aggregate demand curve. Like all aggregate demand curves, this one is constructed based on several ceteris paribus aggregate demand determinants, such as physical wealth. The key question is: What happens to the aggregate demand curve if physical wealth changes?

More Physical Wealth

Suppose, for example, that the economy has been growing steadily for a couple of years. Real production has expanded. Disposable incomes have risen. And most importantly, the household sector has devoted a significant portion of consumption expenditures to the purchase of durable goods, such as cars, houses, furniture, and appliances. This accumulation of durable goods has added to the physical wealth of the household sector. With this increase in physical wealth, with this stockpile of relatively new durable goods that will be functioning for several years, the household sector is inclined to decrease consumption expenditures.

The household sector reduces consumption by increasing saving. This saving could take the form of simply diverting more disposable income into bank savings accounts or other financial assets. However, it is also likely to take the form of making payments on the loans used to purchase these durable goods. Because loan repayments are income that is NOT used to buy current production it is considering saving. The result is that this increase in physical wealth causes a decrease in consumption expenditures and subsequently a decrease in aggregate demand.

To see how an increase in physical wealth affects the aggregate demand curve, click the [More Wealth] button. The accumulation of physical wealth triggers a decrease in aggregate demand, which is a leftward shift of the aggregate demand curve.

Less Physical Wealth

Alternatively, suppose that the economy has been through a contraction. Real production has fallen. Disposable incomes have declined. And most importantly, the household sector has NOT purchased many durable goods, such as cars, houses, furniture, and appliances for a while. People have had to "make due" with existing durable goods. But these durable goods are wearing out, breaking down, and depreciating. In essence, the physical wealth of the household sector is decreasing. Moreover, loans used to finance previous durable good purchases are being paid off. With this decrease in physical wealth and with less outstanding debt the household sector is inclined to increase consumption expenditures, especially to purchase needed durable goods.

The household sector is able to pay for this extra consumption, even though disposable income might not be rising, by decreasing saving. This saving could take the form of simply withdrawing funds from existing bank savings accounts or "cashing in" other financial assets. However, it is also likely to take the form of getting loans through financial markets. The result is that this decrease in physical wealth causes an increase in consumption expenditures and subsequently an increase in aggregate demand.

To see how a decrease in physical wealth affects the aggregate demand curve, click the [Less Wealth] button. The drop in physical wealth triggers an increase in aggregate demand, which is a rightward shift of the aggregate demand curve.

What Does It Mean?

Physical wealth as an aggregate demand determinant is a key part of the business cycle. Household consumption expenditures are the largest of the four expenditure categories, comprising about two-thirds of aggregate expenditures on real production. While consumption is relatively stable compared to the extremely volatile investment, even small changes in this large expenditure category can trigger business-cycle instability. And small changes in consumption can result from changes in physical wealth.

During an expansion, the household sector accumulates physical wealth, especially in the form of durable goods. However, once this physical wealth has been accumulated, the household sector reduces consumption expenditures, often because they are paying off the debt used to buy these durable goods. The drop in consumption induces a decrease in aggregate demand, which can then trigger the onset of a contraction.

During the contraction, the household sector's stockpile of durable goods breaks down, wears out, and otherwise depreciates, meaning physical capital decreases. In addition, debt used to finance the purchase of these durable goods is being paid off. This entices the household sector to increase consumption expenditure, which induces an increase in aggregate demand, and triggers an expansion.

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Recommended Citation:

PHYSICAL WEALTH, AGGREGATE DEMAND DETERMINANT, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2018. [Accessed: July 15, 2018].


Check Out These Related Terms...

     | aggregate demand determinants | interest rates, aggregate demand determinant | federal deficit, aggregate demand determinant | inflationary expectations, aggregate demand determinant | money supply, aggregate demand determinant | consumer confidence, aggregate demand determinant | exchange rates, aggregate demand determinant | financial wealth, aggregate demand determinant | change in aggregate demand | change in aggregate expenditures | aggregate demand shifts | slope, aggregate demand curve | aggregate supply determinants |


Or For A Little Background...

     | aggregate demand | aggregate expenditures | aggregate demand and market demand | determinants | gross domestic product | consumption expenditures | investment expenditures | government purchases | net exports | price level | real production | GDP price deflator | real gross domestic product | business cycles |


And For Further Study...

     | AS-AD analysis | aggregate market | business cycles | circular flow | Keynesian economics | monetary economics | aggregate market shocks | investment-driven business cycles |


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