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Aggregate demand (AD)

Aggregate demand is the total spending on goods and services in a period of time at a given price level.

On the horizontal axis, real GDP is measured. For our measure of the price level, we use the GDP price deflator on the vertical axis. The aggregate demand curve is labeled AD.


Components of Aggregate Demand

Consumption is spending by households on goods and services. Goods include household spending on durable goods, such as automobiles and appliances, and non durable goods, such as food and clothing. Services include such intangible items as haircuts and medical care.

Investment is the purchase of goods that will be used in the future to produce more goods and services. It is the sum of purchases of capital equipment, inventories and structures.

Government Purchases include spending on goods and services by local, state and central governments. It includes the salaries of government workers as well as expenditures on public works.

Net Exports equal the foreign purchase of domestically produced goods(exports) minus the domestic purchases of foreign goods (imports). The net in net exports refers to the facts that imports are subtracted from exports.

Aggregate Demand Formula


Why AD curve slopes downwards

There are economywide reasons that cause the aggregate demand curve to slope downward. They involve at least three distinct forces:

The real-balance effect: The change in expenditures resulting from a change in the real value of money balances when the price level changes, all other things held constant; also called the wealth effect. A rise in the price level will have an effect on spending.

Interest rate effect: One of the reasons that the aggregate demand curve slopes downward: Higher price levels increase the interest rate, which in turn causes businesses and consumers to reduce desired spending due to the higher cost of borrowing.

The open economy effect: One of the reasons that the aggregate demand curve slopes downward: Higher price levels for an economy result in foreign residents desiring to buy fewer exports, while local residents now desire more foreign-made goods, thereby reducing net exports. This is equivalent to a reduction in the amount of real goods and services purchased in the economy.

Changes in AD

Movement along the AD curve is caused due to the change in price level in the economy.


Any non-price-level change that increases aggregate spending (on domestic goods) shifts AD to the right. Any non-price-level change that decreases aggregate spending (on domestic goods) shifts AD to the left.

Increase in any components of AD will result in the shift of AD curve to the right and a fall in the value of any component will result in the fall of AD and the AD curve will shift to the left.


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