Aggregate Demand

Definition and Formulae

Aggregate Demand (AD) is the total demand for goods and services within a particular market or economy.
The basic equation for calculating aggregate demand is AD = C + I + G + (X-M).
In this equation, C represents consumer spending, I refers to business investment, G denotes government spending, and X-M is the net exports (exports minus imports).

Key Determinants of Aggregate Demand

Income: When households have more disposable income, they are likely to spend more, increasing consumption (C).
Wealth: An increase in wealth can encourage more spending, increasing consumption (C).
Interest rates: Lower interest rates can inspire more borrowing and less saving, boosting consumer spending (C) and investment (I).
Business Confidence: When businesses are more confident about the future, they are likely to invest more, hence increasing business investment (I).
Government Policy: A rise in public sector spending or a reduction in taxes can boost aggregate demand, as they increase both government spending (G) and disposable income.

Shifts in Aggregate Demand Curve

The aggregate demand curve is downward sloping because as the average price level decreases, real income increases, leading to an increase in quantity demanded.
Any changes in the factors affecting C, I, G, or (X-M) can cause the aggregate demand curve to shift.
The curve shifts to the right when there is an increase in aggregate demand, and to the left when there is a decrease.

Interactions with Aggregate Supply

When Aggregate Supply (AS) equals Aggregate Demand (AD), that’s the point of macroeconomic equilibrium.
If AD increases faster than AS, inflation can occur. If AS increases faster than AD, deflation can occur.
Policymakers can influence AD through fiscal and monetary policy to help achieve macroeconomic goals such as full employment or price stability.

Effects of International Trade

Net exports (X-M) is a component of AD. Therefore, changes in a country’s international trade can affect its AD.
Higher exports can increase AD while higher imports can decrease AD.
Exchange rate fluctuations can also affect AD. For instance, depreciation in the domestic currency can make exports cheaper and imports expensive, potentially increasing AD.