3.1 Aggregate Demand

What is Aggregate Demand?

Aggregate demand (AD) shows the total quantity of goods and services demanded in an economy at each price level, in a given time period. The AD curve slopes downward, showing an inverse relationship between the price level and real GDP demanded. AD = C + I + G + Xn (consumption + investment + government spending + net exports).

Why AD Slopes Downward

Three effects explain the downward slope: the real balances (wealth) effect — lower price level increases purchasing power of money, raising consumption; the interest rate effect — lower price level reduces demand for money, lowering interest rates and boosting investment; the foreign purchases effect — lower price level makes domestic goods cheaper relative to foreign goods, raising net exports.

Shifters of Aggregate Demand

AD shifts (not slides along the curve) when a component of C+I+G+Xn changes at a given price level. Shifters include changes in consumer confidence, wealth, interest rates, expected inflation, government spending/taxes, income abroad, and exchange rates. An increase shifts AD right; a decrease shifts AD left.

Key terms

Aggregate Demand (AD)

The total quantity of goods and services demanded in an economy at each price level; AD = C + I + G + Xn.

Real balances (wealth) effect

A lower price level increases the purchasing power of money, raising consumption and increasing quantity of real GDP demanded.

Interest rate effect

A lower price level reduces money demand, lowering interest rates and increasing investment spending.

Foreign purchases effect

A lower domestic price level makes domestic goods cheaper relative to foreign goods, increasing net exports.

AD shifters

Changes in consumer confidence, wealth, interest rates, expected inflation, government policy, foreign income, or exchange rates shift the AD curve left or right.

Try an AP-style question

Which explains the downward slope of AD?

1. Changes in potential GDP
2. The real wealth effect
3. Rising input costs
4. Technology changes