Aggregate Demand (AD)

What is Aggregate Demand (AD)?

Aggregate Demand is the overall demand for all the goods and services in the country’s economy and is expressed as the total amount of the money 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 bought within the country with their prices.

Formula

The aggregate demand is calculated using the different components, including consumer spending, Government spending, investment spending, and the country’s net exports.

Aggregate Demand Formula (AD) = C + I + G + (X – M)

Aggregate-Demand-Formula

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For eg:
Source: Aggregate Demand (AD) (wallstreetmojo.com)

The difference between exports (X) and imports (M) is also called 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. Then 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)
Aggregate Demand Example

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 compares the aggregate demand of two economies – Economic A and Economic B. He gets the following data:

Consumption (C)Economy A (in a million)Economy B (in a million)
$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

Example 3.2
Example 3.3

For Economy B

Example 3.4

Aggregate demand for Economy A is $115 million, and that of Economy B is $160 million.

Therefore, the size of Economy B is larger.

Advantages

  1. It helps in knowing the total demand for all the goods and services in the economy during the given period.
  2. It is used by many economists and market analysts for their research.
  3. 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

  1. 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 moreand aggregate demand is the same, they only increase concurrently, and it does not show cause and effect.
  2. In the calculation of AD, many of the different economic transactions between the country’s millions of individuals for different purposes are involved, making it difficult to calculate variations, run regressions, etc.

Important points

  1. The aggregate demand curve slopes downward from left to right. When the prices of the goods or services increase or decrease, 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 country’s economy.
  2. As the market values measure the AD in a country, 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 country’s people.

Conclusion

Aggregate Demand is the overall demand for all the goods and services in the country’s economy. It is a macroeconomic term, describing the relationship between all the things bought within the country and 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 country’s people. 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.

Recommended Articles

This has been a guide to Aggregate Demand and its definition. Here we discuss how to calculate aggregate demand using its formula and practical examples. You can learn more about accounting from the following articles –

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