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Aggregate demand

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Last editedDec 20202 min read

Aggregate demand is closely tied to gross domestic product (GDP), serving as an economic measurement of an economy’s production. Find out more about how aggregate demand is defined as well as how it’s calculated below.

Introduction to aggregate demand

When you want to look at the bigger picture of production, aggregate demand is a useful metric. This term is used in economics, referring to the total amount of demand for all finished products and services. It’s expressed as a monetary value, showing the amount paid for all of the goods and services produced at a specific price and point in time.

The difference between GDP and aggregate demand is that while GDP shows the total amount of goods produced in the economy over the long term, aggregate demand refers to the demand for those goods at a specific point in time. Yet while the concepts differ in terms of timeframe, GDP and aggregate demand are closely related. When one increases, so does the other. When you calculate aggregate demand over a longer term and adjust for price level, it will equal the GDP.

There are a number of components of aggregate demand, including capital goods, consumer goods, imports, exports, and government spending. All of these variables are added together to determine an economy’s overall production demand.

What is the aggregate demand curve?

This measurement can easily be represented graphically with the aggregate demand curve. Here’s how to graph aggregate demand with a visual display:

  1. Graph the aggregate amount of goods and services demand on the X-axis

  2. Graph the price level of these goods and services on the Y-axis

Like other demand curves, the aggregate demand curve will slope from left to right in a downward direction. You’ll see when graphing aggregate demand that as prices decrease, demand rises as consumers can purchase more goods. As prices increase, demand falls due to the higher cost of goods. However, there are additional factors that can influence aggregate demand, including taxes or interest rates.

How to calculate aggregate demand

There are a few figures you’ll need to have close to hand to figure out how to calculate aggregate demand. The aggregate demand formula adds together consumer spending, government spending, private investment, and the number of net exports.

The formula looks like this:

Aggregate Demand = C + I + G + (E-M)

We’ll break down these components below.

Components of aggregate demand

Here’s a closer look at the components of aggregate demand used in the equation above.

  • Consumption (C): This includes disposable income, or the money that consumers have available for purchasing goods and services.

  • Investment (I): This includes investment from businesses or corporations, rather than individual consumers.

  • Government Spending (G): This includes spending on infrastructure projects like roads and schools, along with benefits paid out and pensions.

  • Net Exports (E-M): This portion of the aggregate demand formula covers the total exports (E) minus the total imports (M).

By working out all of these components, you can then add them up to determine the time period’s total aggregate demand.

Influences on aggregate demand

In addition to the components listed above, there are also a number of economic factors that can impact aggregate demand.

  • Interest Rates: When the government lowers interest rates, it encourages consumers to purchase items like property and electronics at lower borrowing cost. Businesses are also able to borrow at these lower rates, which increases their own spending. The opposite effect happens when interest rates rise, kerbing spending.

  • Currency Exchange Rates: Currency values are always fluctuating. When the value of the pound falls, it means that British consumers are less likely to purchase goods from abroad. Instead, they may purchase more products at home, increasing aggregate demand.

  • Household Income: The overall economic picture will have a direct impact on aggregate demand. When household income or wealth is high, aggregate demand increases because households have more discretionary income to spend on goods. However, when income declines, consumers tighten their belts which reduces demand for goods.

As you can see, aggregate demand is influenced by numerous factors and components. By tracking this figure, you can gain a wider insight into the economy’s current state.

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