Aggregate Demand

Overview

Aggregate demand (AD) refers to the total spending on goods and services in a given economy during a certain period of time.
It is calculated by adding the expenditure of consumers, businesses, the government, and foreign entities.

Consumer spending (C): This is the total expenditure by households in an economy.
Investment spending (I): This is spending by firms on capital goods which help increase their output, such as factories, machinery etc.
Government spending (G): Expenditure by the government within the economy.
Net Exports (X-M): This is the value of a country’s exports minus the value of its imports.

Position: The AD curve shows the quantity of all goods and services (real GDP) that buyers are willing and able to purchase at different price levels.
Slope: The AD curve is downward sloping because of the wealth effect, interest rate effect, and international trade effect.
Shifts: Any change in C, I, G or (X-M) not caused by changes in domestic price level will cause the AD curve to shift.

Consumers’ Confidence: When optimism is high, consumers are more likely to spend, and AD will increase.
Interest Rates: Lower interest rates decrease the cost of borrowing and encourage spending, increasing AD.
Government Policy: Expansionary fiscal policy (increased government spending and/or tax cuts) and monetary policy (lower interest rates) both increase AD.
External Factors: Conditions in foreign economies can affect demand for exports, impacting AD.

Understanding AD is crucial in managing an economy as it shows the relationship between total spending and output, employment, and inflation in the economy.
Policymakers use understanding of AD to implement policies to improve the overall economic well-being.

AD is a macroeconomic concept and may not provide insights into the microeconomic behaviours of individuals and firms.
It assumes all other things being constant, which can lead to oversimplification.
Changes in AD impact the economy with a time lag and it may be difficult to predict the exact timing and magnitude of their effects.
The relationship between AD and the price level assumes a closed economy with no international trade. This assumption can limit the accuracy of AD analysis in an open economy.