Cambridge International AS and A Level Economics: Components of AD, the accelerator and output gaps (9708)

This guide covers outcomes 9.1.2 (components of Aggregate Demand and their determinants) and 9.1.3 (full employment and equilibrium national income, inflationary and deflationary gaps) of the Cambridge International AS & A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028. Topic 9 is A Level content only and is not examined at AS. Treat the AS topics as background. Each country, firm and number here is made up to show the method, so none is a real statistic. Money is in currency units (cu).

Start from the Cambridge A Level Economics hub or the printable checklist. After this guide, use the revision notes and the practice questions. For AD and AS curves see the AD and AS guide. A free 10-minute diagnostic shows where you stand. The multiplier formulae and the propensities (aps, mps, apc, mpc and so on) belong to 9.1.1 and are not taught here.

Scope of this guide

Outcome	Skill
9.1.2	Explain consumption, autonomous and induced; the savings function, autonomous and induced
9.1.2	Explain autonomous and induced investment, and the accelerator
9.1.2	Explain government spending and net exports (exports minus imports)
9.1.3	Distinguish full employment national income from equilibrium national income
9.1.3	Explain inflationary and deflationary gaps

The consumption function

Aggregate demand is C + I + G + (X - M). Consumption (C) is household spending on goods and services. The consumption function links it to income. In a simple linear form:

C = a + bY, where Y is national income.

• Autonomous consumption (a) is spending that does not depend on current income. A household with no income still has to eat, so it borrows or draws on savings.
• Induced consumption (bY) is the part that changes when income changes.

Worked example (Country A, illustrative). C = 60 + 0.75Y.

Y	Autonomous	Induced (0.75Y)	C	S (Y - C)
0	60	0	60	-60
100	60	75	135	-35
200	60	150	210	-10
240	60	180	240	0
300	60	225	285	15
400	60	300	360	40

At Y = 240, C = Y, so saving is zero. Below that, households dissave (spend more than they earn). When income rises from 300 to 400, consumption rises by 75. That is a movement along the function, caused by income.

A shift of the whole function comes from a change in anything else. If confidence falls and autonomous consumption drops from 60 to 50, then C = 50 + 0.75Y and consumption at Y = 400 is 350, which is 10 lower at every income.

Determinants of autonomous consumption (shifters): household wealth (such as house or share prices), interest rates, the availability of credit, consumer confidence and expectations of future income, and the age structure of the population. Taxes on income change the disposable income that induced spending depends on.

The savings function

Saving is income not spent. With no tax, S = Y - C, so S = Y - (a + bY) = -a + (1 - b)Y.

• Autonomous saving is the negative intercept (-60 in Country A): the dissaving at zero income.
• Induced saving is the part that rises with income (0.25Y in Country A).

Check with the table: at Y = 300, S = -60 + 0.25 × 300 = 15, which matches Y - C = 300 - 285. Saving and consumption are two sides of the same decision, so anything that shifts the consumption function up shifts the savings function down by the same amount. Higher interest rates reward saving and make borrowing dearer, which tends to lower autonomous consumption and raise saving at each income.

Investment and the accelerator

Investment (I) is firms’ spending on capital goods such as machinery, buildings and equipment, plus changes in stocks. Do not confuse it with buying shares.

• Autonomous investment does not depend on current national income. Examples are government-backed projects, spending driven by new technology, and spending driven by business confidence or a fall in interest rates.
• Induced investment changes with income or, more precisely, with changes in income. The accelerator explains this.

Determinants of investment: the rate of interest (the cost of borrowing and the return forgone on own funds), expected profit and business confidence, the rate of growth of demand, technological change, corporation tax and allowances, the availability of credit, and the cost of capital goods.

The accelerator

In the accelerator model, firms plan net investment from how fast output is changing, not from how high it is. If firms need v units of capital for each unit of annual output (the accelerator coefficient, or capital-output ratio), then:

Net investment = v × change in output.

Worked example (Country B, illustrative; v = 3, depreciation 10 a year).

Year	Output Y	Change in Y	Growth	Capital needed (3Y)	Net investment	Gross investment
0	200			600
1	210	+10	5.0%	630	30	40
2	225	+15	7.1%	675	45	55
3	235	+10	4.4%	705	30	40
4	235	0	0%	705	0	10
5	230	-5	-2.1%	690	-15	0

Gross investment is net investment plus replacement of worn-out capital (10 here).

Four lessons from the table:

1. In year 3 output is still rising, yet investment falls from 45 to 30 because output grows by less than before.
2. When output stops growing (year 4), net investment is zero and only replacement remains.
3. In year 5 the model wants net investment of -15, but firms can only shrink capital by not replacing it. Depreciation is 10, so gross investment cannot go below zero, and the extra 5 units of capital stay idle.
4. A small change in the growth of output causes a much larger change in investment, which is why investment is a volatile part of AD.

Limits of the accelerator: it assumes firms run at full capacity, so spare capacity weakens it. It assumes firms treat a rise in demand as lasting; if they expect it to be temporary they will not invest. It assumes capital goods can be supplied at once, that credit is available, and that v is constant. Real investment also depends on interest rates and confidence. The accelerator is best seen as one cause of fluctuations in investment, not a full theory.

Government spending

Government spending (G) in AD is spending on goods and services: public-sector wages, health and education provision, and capital projects such as roads. Transfer payments (pensions, benefits) are not part of G, because nothing is produced in exchange. They affect AD only when recipients spend them, so they appear in C.

Worked example. A government spends 40 cu on public-sector pay, 20 cu on a new rail line and 30 cu on benefits. G in AD = 40 + 20 = 60 cu. The 30 cu of benefits is excluded.

Most G is treated as autonomous, because decisions come from policy, not from current income. It can change with the political priorities of the government, the stage of the economic cycle (spending on benefits rises in a downturn and tax revenue falls), the size of the budget deficit and national debt, and fiscal policy aims. A rise in G of 15 cu (from 60 to 75) shifts the AD schedule up by 15 at every level of income.

Net exports

Net exports are exports minus imports (X - M). Exports are demand from abroad for domestic output, so they depend on foreign income, the exchange rate, relative prices and quality, and trade barriers. Imports rise with domestic income, so most imports are induced. A part is autonomous.

Worked example (Country A). X = 90 and M = 20 + 0.15Y.

• At Y = 400, M = 20 + 60 = 80, so X - M = 10.
• At Y = 600, M = 20 + 90 = 110, so X - M = -20.

Higher income pulls in more imports, so net exports fall as Y rises. If foreign incomes grow and exports rise by 12 to 102, net exports at Y = 400 become 22. A lower exchange rate usually makes exports cheaper abroad and imports dearer at home, and so tends to raise X - M, but the size depends on how responsive buyers are to price.

Equilibrium and full employment

Equilibrium national income is where planned AD equals income (Y = AD). The full employment level of national income is the level of output when the economy uses its resources at normal capacity. The two need not be equal.

Worked example (Country A). C = 60 + 0.75Y, I = 50, G = 60, X = 90, M = 20 + 0.15Y. Then AD = 60 + 0.75Y + 50 + 60 + 90 - 20 - 0.15Y = 240 + 0.6Y.

Y	C	M	AD	AD - Y
400	360	80	480	+80
500	435	95	540	+40
600	510	110	600	0
700	585	125	660	-40

Where AD exceeds Y, firms see stocks fall and raise output. Where AD is below Y, stocks build up and output falls. Equilibrium is Y = 600.

Deflationary and inflationary gaps

Suppose full employment income is 700 in Country A.

Deflationary gap. At Y = 700, AD = 660. AD is 40 too low to buy full-employment output. The deflationary gap is 40, measured as the vertical distance between the 45-degree line (AD = Y) and the AD line at full employment. Equilibrium (600) is 100 below full employment: the shortfall of income. The AD gap and the income gap are linked by the multiplier, which is the subject of the multiplier unit under 9.1.1. Output is below potential, so unemployment is likely to be above its natural level.

Inflationary gap. Later, optimism lifts investment from 50 to 110 and exports rise by 30. AD becomes 240 + 90 + 0.6Y = 330 + 0.6Y. At Y = 700, AD = 750. AD is 50 more than full-employment output can supply, so the inflationary gap is 50. The model’s equilibrium is 825, but real output cannot rise beyond 700 for long. Spending beyond capacity bids up prices, which is demand-pull inflation. In AD and AS terms, the gap appears when AD cuts SRAS to the right of LRAS.

A question may use either measure of the gap, so say which one you use.

Evaluating gaps

• Measuring full employment is hard. It is an estimate. If full employment income in Country A were 650, AD at 650 would be 240 + 0.6 × 650 = 630, so the deflationary gap would be only 20, not 40.
• Self-correction is disputed. Some economists expect a deflationary gap to close as wages and prices fall. Others expect a long period of unemployment, which favours demand management.
• Policy lags. By the time action takes effect, the gap may have changed.
• Both gaps can exist for one economy at different times, so the cycle matters.

Common errors

• Putting transfer payments inside G.
• Calling a rise in income a shift of the consumption function.
• Saying the accelerator makes investment depend on the level of output. It depends on the change.
• Treating all imports as autonomous.
• Measuring a gap against equilibrium income when the question wants the vertical gap in AD.
• Forgetting that gross investment cannot be negative.

Official syllabus

Cambridge International AS & A Level Economics 9708, syllabus for examination in 2026, 2027 and 2028, version 2, published by Cambridge University Press & Assessment. This guide covers outcomes 9.1.2 and 9.1.3.