Aggregate Demand

Definition

Aggregate demand is an economic measurement of the total amount of demand for all finished
goods and services produced in an economy. Aggregate demand is expressed as the total amount
of money exchanged for those goods and services at a specific price level and point in time.

Understanding Aggregate Demand

Aggregate demand represents the total demand for goods and services at any given price level in
a given period. Aggregate demand over the long-term equals gross domestic product
(GDP) because the two metrics are calculated in the same way. GDP represents the total amount
of goods and services produced in an economy while aggregate demand is the demand or
desire for those goods. As a result of the same calculation methods, the aggregate demand and
GDP increase or decrease together.

Technically speaking, aggregate demand only equals GDP in the long run after adjusting for
the price level. This is because short-run aggregate demand measures total output for a single
nominal price level whereby nominal is not adjusted for inflation. Other variations in
calculations can occur depending on the methodologies used and the various components.

Aggregate demand consists of all consumer goods, capital goods (factories and equipment),

exports, imports, and government spending programs. The variables are all considered equal as
long as they trade at the same market value.

Aggregate Demand Curve

If you were to represent aggregate demand graphically, the aggregate amount of goods and
services demanded is represented on the horizontal X-axis, and the overall price level of the
entire basket of goods and services is represented on the vertical Y-axis.

The aggregate demand curve, like most typical demand curves, slopes downward from left to
right. Demand increases or decreases along the curve as prices for goods and services either
increase or decrease. Also, the curve can shift due to changes in the money supply, or increases
and decreases in tax rates.

Calculating Aggregate Demand

The equation for aggregate demand adds the amount of consumer spending, private investment,
government spending, and the net of exports and imports. The formula is shown as follows: AD
= C + I + G + Nx

Where:

 C = Consumer spending on goods and services

 I = Private investment and corporate spending on non-final capital goods (factories,
equipment, etc.)
 G = Government spending on public goods and social services (infrastructure, Medicare,
etc.)
 Nx = Net exports (exports minus imports)

The aggregate demand formula above is also used by the Bureau of Economic Analysis to
measure GDP in the U.S.

Factors That Can Affect Aggregate Demand

The following are some of the key economic factors that can affect the aggregate demand in an
economy.

Changes in Interest Rates

Whether interest rates are rising or falling will affect decisions made by consumers and
businesses. Lower interest rates will lower the borrowing costs for big-ticket items such as
appliances, vehicles, and homes. Also, companies will be able to borrow at lower rates, which
tends to lead to capital spending increases.

Conversely, higher interest rates increase the cost of borrowing for consumers and companies.
As a result, spending tends to decline or grow at a slower pace, depending on the extent of the
increase in rates.
Income and Wealth
As household wealth increases, aggregate demand usually increases as well. Conversely, a
decline in wealth usually leads to lower aggregate demand. Increases in personal savings will
also lead to less demand for goods, which tends to occur during recessions. When consumers are
feeling good about the economy, they tend to spend more leading to a decline in savings.

Changes in Inflation Expectations

Consumers who feel that inflation will increase or prices will rise, tend to make purchases now,
which leads to rising aggregate demand. But if consumers believe prices will fall in the future,
aggregate demand tends to fall as well.

Currency Exchange Rate Changes

If the value of the U.S. dollar falls (or rises), foreign goods will become more (or less
expensive). Meanwhile, goods manufactured in the U.S. will become cheaper (or more
expensive) for foreign markets. Aggregate demand will, therefore, increase (or decrease).