Aggregate demand (AD) is the total amount of goods and services that people want to buy in the economy at a certain price level. It has four main parts: consumption (C), investment (I), government spending (G), and net exports (X-M). Consumer and business confidence are really important for these parts, especially consumption and investment, which greatly affect the overall aggregate demand.

Consumer Confidence

1. What It Is and How It Affects Spending:

   • Consumer confidence shows how happy or worried people are about their money and the economy as a whole.
   • When consumer confidence is high, people tend to spend more money. But when it’s low, people usually spend less.

2. Evidence From Surveys:

   • A survey by the GfK consumer confidence index in Britain found that a small increase in the index often leads to a big jump in retail spending.
   • For example, when the index went from -9 to -2 in late 2020, retail sales went up by about 2.6% in the next quarter.
   • This shows that when families feel good about their finances, they are more likely to spend money, which boosts consumption (C) and aggregate demand.

3. Real-Life Examples:

   • During the COVID-19 pandemic, consumer confidence dropped a lot. The index fell to -34 in April 2020, showing how uncertain people felt. Because of this, spending dropped by 30% in the second quarter of 2020.
   • However, when confidence started to improve in mid-2021, people began to spend again, helping aggregate demand bounce back.

Business Confidence

1. What It Is and Its Effects:

   • Business confidence is about how companies feel about the economy and their own future.
   • When business confidence is high, companies invest more in things like new equipment. Low confidence, on the other hand, means companies may hold back on spending.

2. Proof From Reports:

   • The British Chambers of Commerce found that when business confidence goes up, investment levels rise too.
   • For example, a 10% rise in the business confidence index can lead to a 5% boost in capital investment.
   • In 2016, after the Brexit vote, business confidence dropped sharply, causing UK companies to plan £1.3 billion less in investments.

3. Trends Over Time:

   • A big study showed that when business confidence was highest in 2015, business investments reached £123 billion. However, after 2016, investments fell to £100 billion by 2019 due to worries about Brexit.

Aggregate Demand and the Multiplier Effect

• The link between consumer and business confidence and aggregate demand can also be explained by the multiplier effect.
• When people spend more, businesses see higher demand for their products, which leads to more production and higher incomes. This, in turn, leads to even more spending in the economy.
• The formula for the multiplier is $k = \frac{1}{1 - MPC}$ where $MPC$ stands for the Marginal Propensity to Consume. For example, if $MPC = 0.8$, then the multiplier $k$ is 5. This means that for every £1 increase in spending, the total output can increase by £5.

Conclusion

In conclusion, consumer and business confidence play a major role in shaping aggregate demand. High confidence usually means more spending and investment, which helps the economy grow. On the flip side, low confidence can lead to less spending and slow down the economy. Understanding these connections is key for policymakers who want to stabilize or improve the economy. It shows how important feelings about the economy are for everyone involved.