Aggregate Demand Defined
Definition
Aggregate demand (AD): the total planned spending on a country's goods and services at each average price level over a period of time.
Unpacking the Definition
- AD adds up the planned spending of every buyer in the whole economy at each average price level.
- The word planned means intended spending, not spending that has already taken place.
- It is measured over a period of time, so AD is a flow, not a stock.
- It is measured at each average price level, which is why AD can be plotted against the price level.
Key Idea
- AD is the demand side of the AD–AS model of the whole economy.
- Consumption (C) is normally the largest single component in most economies.
The Four Components
Aggregate demand:
AD=C+I+G+(X−M) AD = C + I + G + (X - M) AD=C+I+G+(X−M)- Consumption (C) is household spending on goods and services, normally the largest component.
- Investment (I) is firms' spending on capital goods such as machinery and buildings.
- Government spending (G) is state spending on goods and services such as schools and roads.
- Net exports (X − M) are exports minus imports, which can be positive or negative.
Example
- At one average price level, households plan consumption, firms plan investment, the government plans spending, and foreign buyers plan to buy exports.
- Add C, I and G to get planned domestic spending, then add exports and subtract imports because imports are spending on foreign output.
- The resulting figure is AD at that price level; because it is planned spending, realised spending may differ if plans are not carried out.
AD Versus Market Demand
- AD adds up planned spending across every market in the economy, so it is a macroeconomic total.
- The demand curve for a single good is a microeconomic idea; a change in one good's price need not change AD.
Exam technique
- State that AD is total planned spending at each average price level.
- List all four components and never omit net exports.
Common Mistake
- Do not confuse aggregate demand with the demand for a single good.
- Do not leave a component out of the definition.
Self review
- Define aggregate demand.
- What does 'planned' expenditure mean?
- List the four components of AD.
- How are net exports calculated?
