Domestic demand is the expenditure on goods, services and investment made by residents of a country during a certain period of time.
The internal demand corresponds to the expenditure made by the resident economic agents of a country (people, companies and the government), in goods and services for both consumption and investment , during a certain period of time (usually measured every year). It should be noted that domestic demand is a very important indicator of the degree of development and level of well-being of a country, when domestic demand grows, the economy tends to grow (with greater production and employment).
As we will see later, domestic demand in an open economy is equal to aggregate demandminus net exports .
Components of internal demand
The three elements of domestic demand are the following:
- Household consumption (C): corresponds to the expense that people and families make in goods and services to meet their daily needs. This expense includes food, clothing, hairdressing services, schools, etc. Housing purchase is excluded.
- Government expenditure (G): refers to the expenditure (both in consumption and investment) made by the government through its public administrations (central, regional and local) to carry out its activities. This expense includes office supplies, salaries of public workers, office rentals, etc.
- Investment (I): is the expenditure on durable goods that companies make in order to produce other goods and services. It also includes spending on stocks (raw materials, semi-processed products, etc.) and the purchase of housing by households. Some examples of investment spending are machinery for making bread, vehicles for transporting goods, buildings, etc.
How internal demand is measured
Case of a closed economy
In a closed economy, internal demand (ID) is equal to the sum of Consumption, Investment and Government Expenditure. There are no imports or exports, so aggregate demand (DA), which is the sum of domestic demand and net demand of residents abroad, is equal to internal demand (ID).
DA = C + I + G = DI
Where:
C = Household consumption
I = investment
G = Government spending
Case of an open economy
In the case of an open economy, domestic demand for subtracting the aggregate demand (AD) net demand for foreign residents, or what is the same, the net exports (X- M).
DA = C + I + G + (XM)
Where:
XN = XM = Exports – Imports
And as DI = DA – XN. If we subtract the net exports (XN) we will obtain the (DI):
DI = C + I + G
Determinants of internal demand
There are several factors that can affect the domestic demand of a country, here are some of them:
- When a country’s unemployment rate is low, demand tends to increase.
- As the country grows faster, demand tends to grow.
- If consumers have good expectations of the country’s economic future, demand tends to grow.
Domestic demand can be a very important engine in the growth of a country. However, when demand growth is based on uncontrolled indebtedness or government subsidies to favor domestic producers, there is a very significant risk of an economic slowdown. It is key then that economic policies tend to favor a healthy demand in line with the country’s income and growth expectations.
