AD= C+I+G+(X-M)

Consumption – This is comprised of the purchasing of goods and services by firms and consumers, low interest rates and inflation can encourage spending whereas deflation and high interest rates can encourage saving. If consumption increases then it will cause AD to increase subsequently which can lead to inflation and increases in national income (NY).

Investment – Investment is the purchasing of capital goods that are used to increase future production and aren’t consumed today, Often several £ of capital is needed to produce one £ of consumer goods. Investment can be manipulated using interest rates (a Monetary policy) which affects the cost of borrowing, so lower interest rates can mean more borrowing and therefore more investment.

Government Spending – Increases in Government spending (a Fiscal policy) can increase AD, however when the government has to borrow money in order to fund spending it can cause ‘crowding out’ decreasing borrowing/investment and therefore the effect on AD but this effect is debatable. As government spending can affect AD it can be used to influence inflation rates.

Current Account – Exports (X) – Imports (M) also known as the balance of payments on the current account is the difference between exports and imports. Imports have a negative effect on AD causing it to decrease whereas Exports have the opposite effect causing AD to increase. Interest rates can have a massive effect on the balance of payment by making exports and imports relatively cheaper or more expensive.