Aggregate demand is a measure of total demand in an economy at different price levels. It is calculated by adding consumer spending, capital investment, government spending, and net exports. It can be used to predict spending habits and is part of the AS-AD model. Rising unemployment leads to a contraction in consumption and a shift in the aggregate demand curve.
In macroeconomics, aggregate demand is a statistical measure that reflects the total demand present in a given economy at different price levels. It is used by itself and in conjunction with other measures, such as aggregate supply, in economic analysis. Alone, aggregate demand is also known as total spending and can be used as a way to show the total demand for a country’s total gross domestic product (GDP).
Aggregate demand can be calculated by adding a country’s total consumer spending, total capital investment by firms, total government spending, and the difference of its exports minus imports. The basic mathematical formula can be expressed like this, AD = C + I + G + (XM). When calculated for different prices, an aggregate demand curve emerges, revealing lower levels of demand at higher prices and increased demand at lower prices. On a chart that graphs price and quantity, this appears as a straight line sloping downward.
While the general formula for this measurement seems relatively simplistic, each of the elements that must be added together can be complex on its own. For example, total consumer spending is actually made up of consumer income minus taxes. Likewise, commercial investment often depends on several factors, including the current interest rate. A higher interest rate means that money is more expensive to borrow, which in turn means that companies will borrow and invest less.
Government spending, as it relates to aggregate demand, consists of everything from government employee salaries to money spent on tanks, agriculture, and welfare. It’s usually one of the biggest parts of the equation. The final part, exports minus imports, is often referred to simply as net exports. This is heavily impacted by the exchange rate of a country’s currency. A higher currency generally results in more imports and less exports, leading to an overall decrease in GDP.
When combined with aggregated supply, aggregated demand values can be used to generate what is known as an AS-AD model. This appears on a graph with demand as a downward sloping line and supply as an upward sloping line crossing midway. This intersection point is known as the break-even point and is the balance between price and output where free markets tend to gravitate. This chart can be used to predict how various factors might impact a population’s spending habits, among other things.
For example, rising unemployment would lead to less disposable income and therefore a contraction in overall consumption. This, in turn, would shift the aggregate demand curve to the left. The new equilibrium point would also shift to the left, further down the aggregate supply curve, to a new level of lower cost and lower supply.