Aggregate Demand

aggregate demand: The amount of total goods and services demanded at a given price level.

• Aggregate demand comes from those who make purchasing decisions in an economy. Each contributor to aggregate demand plays an important role in economic fluctuations. Those who make up aggregate demand for a given country are:
  • You, your mom and dad, your friend, your next door neighbor, and anyone else who demands stuff – you are all consumers. Consumers make up the part of aggregate demand called consumption (C).
  • Businesses — they need stuff to build stuff. They build factories and purchase capital. They are also a part of aggregate demand called investment (I).
  • The government — they buy stuff too. They buy big tanks and lots of lawyers (an example of buying a service). They build roads and dams; buy pens and pencils; and pay for a lot of catered dinners. They are also a part of aggregate demand called government (G).
  • Foreigners — they buy a lot of our stuff too. They buy our banking services, our airplanes, and our music. They are also a part of aggregate demand for their part in net exports (NX).

Note: These are the same elements of GDP which measures overall output.

• Aggregate demand changes when the price level changes. When the general price level is high, there is less demand; when the general price level is low, there is more demand.
  • Why?
    • When everything around you is expensive or getting more expensive (so the general price level is rising), you feel poorer. Because you feel poorer, you demand less goods and services. When everything around you is getting cheaper (price level falling), you feel richer and demand more goods and services.
    • There are slightly more complicated ways in which the price level affects investment and net exports, but the relationship is the same. (For a more comprehensive introduction see an introductory economics textbook such as N. Gregory Mankiw's Principles of Economics 4th Edition chapter 33.
  • As a result, we can draw the aggregate demand curve on a graph with the general price level on the y axis and output (Y) or GDP on the x-axis.

The graph tells us that if there is a change in the price level of the economy (say from 1 to 2) then GDP will fall (say from 100 million to 70 million).

Aggregate demand is also influenced by things other than the price level. Any change to consumption, investment, government spending, or net exports that do not have to do with changes in the overall price level will cause a shift in the aggregate demand curve.