The textbook says that if a firm invests more it increases aggregate demand and hence they respond to this increase in demand by using more labour and other resources hence paying out more incomes to households. How can investment increase aggregate demand? Shouldn't it be the other way around? Mathematically it makes sense if I go by the formula AD= C+I+G+X-M However it doesn't sink in otherwise
Aggregate demand means total spending on domestically produced goods and services. As such, it is defined to include firms' spending on capital goods (machinery, factories etc), denoted by I, in addition to households' spending on consumer goods (C), the government's spending on goods and services (G), plus exports (X) less spending on imports from abroad (M). It is, of course, likely to be true that increases in aggregate demand / total spending will lead to increases in national income / GDP, which will in turn encourage firms to invest more in order to meet the additional demand.
