What is Aggregate Demand (AD)?
Aggregate Demand is the overall total demand of all the goods and the services in the country’s economy and is expressed as a total amount of the money which is exchanged for such goods and services. It equals the demand for the Gross Domestic Product (GDP) of the country and describes the relationship between all the things which are bought within the country with their prices.
Formula
The aggregate demand is calculated using the different components which include Consumer spending, Government spending, investment spending, and the net exports of the country.
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For eg:
Source: Aggregate Demand (AD) (wallstreetmojo.com)
- Consumer Spending (C) – It is the total amount of spending of the families on the final products which are not used for the purpose of the investment.
- Investment Spending (I) – The investment includes all those purchases which are made by the companies for producing consumer goods. However, every purchase is not counted for the aggregate demand as the purchase that only replaces the existing item doesn’t add to the demand.
- Government Spending (G) – It includes Spending of the Government on the public goods and the social services but does not include the transfer payments, like Social Security, Medicaid, and medical care, etc. because they don’t create any demand.
- Exports (X) – It is the total value of foreign countries spending on the goods and services of the home country.
- Imports (M) – It is the total value of spending of the home country on the goods and services imported from foreign countries. This will be deducted from the value of exports of the country to arrive at the net exportsArrive At The Net ExportsNet exports of any country are measured by calculating the value of goods or services exported by the home country minus the value of the goods or services imported by the home country. It includes various goods and services exported and imported by the government, like machinery, cars, consumer goods.read more of the country during the period.
The difference between exports (X) and imports (M) is also referred to as net exports.
Example of the Aggregate Demand
Example #1
Suppose during a year, in the country United States, Personal Consumption Expenditures was $ 15 trillion, Private investment and the corporate spending on the non-final capital goods was $4 trillion, Government Consumption Expenditure was $3 trillion, the value of exports was $ 2 trillion and the value of imports was $1 trillion. Calculate the aggregate demand of the U.S.
Where,
- C = $ 15 trillion
- I = $ 4 trillion
- G = $ 3 trillion.
- Nx (Net Imports) = $ 1 trillion ($2 trillion – $1 trillion)
Now,
- = C + I + G + Nx
- = $ 15 + $ 4 + $ 3 + $ 1 trillion
- = $ 23 trillion
Thus the AD of the U.S. during the period is $ 23 trillion.
Example #2
An Economist is comparing the aggregate demand of two economies – Economy A and Economy B. He gets the following data:
| Particulars | Economy A (in million) | Economy B (in million) |
|---|---|---|
| Consumption (C) | $25 | $30 |
| Investment (I) | $40 | $40 |
| Government Spending (G) | $25 | $80 |
| Exports (X) | $50 | $20 |
| Imports (M) | $25 | $10 |
Calculate and find out which economy has a higher aggregate demand.
Solution:
For Economy A
For Economy B
Aggregate demand for Economy A is $115 million and that of Economy B is $160 million.
Therefore, the size of Economy B is higher.
Advantages
- It helps in knowing the total demand for all the goods and services in the economy during the given period.
- It is used by many of the economist and the market analysts for their research.
- The Aggregate demand curve helps in knowing the effect of change in prices of the goods or the services in an economy on the demand of the products.
Disadvantages
- The calculation of the aggregate demand does not give proof that with the increase in the AD there will be growth in the economy. As the calculation of the gross domestic productCalculation Of The Gross Domestic ProductGDP or gross domestic product refers to the sum of the total monetary value of all finished goods and services produced within the border limits of any country. GDP determines the economic health of a nation. GDP = C + I + G + NXread more and aggregate demand is the same, it shows that they only increase concurrently and it does not show about cause and effect.
- In the calculation of AD, many of the different economic transactions which happen between the millions of the individuals of the country for different purposes are involved, makes it difficult for calculation, variations, run regressionsRegressionsRegression Analysis is a statistical approach for evaluating the relationship between 1 dependent variable & 1 or more independent variables. It is widely used in investing & financing sectors to improve the products & services further. read more, etc.
Important points
- The aggregate demand curve slopes downward from the left to the right. When the prices of the goods or the services increase or decreases then the demand for the product will also either increase or decrease along with the curve. Also, there can be a shift in the curve when there are changes in the money supply in the economy or an increase or decrease in the rate of tax applicable in the economy of the country.
- As the AD in a country is measured by the market values, so it represents only the total output at the given price level which may not necessarily represent the quality of the things or the standard of living of the people of the country.
Conclusion
Aggregate Demand is the overall total demand for all the goods and the services in the country’s economy. It is a macroeconomic term that describes the relationship between all the things which are bought within the country with their prices.
Like the AD in a country is measured by the market values, so it represents only the total output at a given price level which may not necessarily represent the quality of the things or the standard of living of the people of the country. It is computed by adding expenditure on the goods and services purchased by the consumers, investment, spending by the government, and the net exports of the country.
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