Aggregate demand is total planned spending on an economy’s final goods and services. In macroeconomics, it summarizes how much households, firms, government, and foreign buyers want to spend at each overall price level.
The Spending Identity
In an open economy, aggregate demand is commonly written as:
[ AD = C + I + G + (X - M) ]
where C is consumption, I is investment, G is government purchases, and X-M is net exports.
This identity is useful because it shows the main channels through which fiscal policy, monetary policy, confidence, and foreign demand affect total spending.
Why The Aggregate-Demand Curve Slopes Downward
Economists usually draw aggregate demand as downward sloping in price-level and output space. Three common reasons are:
- a lower price level raises real money balances, which can reduce interest rates
- lower interest rates can stimulate investment and other interest-sensitive spending
- a lower domestic price level can improve net exports relative to foreign goods
The exact mechanism depends on the model, but the general idea is that lower overall prices make planned spending larger.
Why AD Matters In The Short Run
When prices and wages are sticky, changes in aggregate demand can move real output and employment rather than just changing prices. A fall in AD can cause recessionary pressure. A rise in AD can increase production if spare capacity exists.
That is why economists use aggregate demand to study recessions, recoveries, stimulus, and monetary tightening.