Understanding Aggregate Demand

by Investing School on June 1, 2011

A concept taken from the world of macroeconomics, aggregate demand is defined as the total demand for completed goods and services in a particular economy, at a specific time and price. Essentially it is the quantity of all the products and services available in an economy which will be bought at all the price levels possible. This includes not just spending on tangible items; it also includes investment spending, government spending and net exports.

The formula for determining aggregate demand (AD) is calculated as follows:

(AD) = C + I + G (X-M)

C = consumers’ spending on goods and services
I = Investment spending by businesses on capital goods
G = government spending on goods and services provided to the public
X = exports of both services and goods
M = imports of both services and goods

An important aspect that doesn’t show in the formula is real interest rates. Lower interest rates in a country will reduce the foreign value of its currency, which leads to a lower prices on the country’s goods abroad (X) and conversely raises the prices paid on foreign goods (M).

Additionally when there is an increase in aggregate demand for output, there is a commensurate increase in production, and just as importantly, employment. That increase in employment also causes a rise in domestic spending which leads to a greater demand on production, becoming, in some ways a self-feeding machine.

The opposite financial term is aggregate supply which defines the total supply of services and goods which are produced by an economy over a specified period of time.

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