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Understanding Aggregate Demand in Macroeconomics

Aggregate demand (AD) measures the total demand for final goods and services in an economy, represented by the AD curve, which slopes downward due to the real income effect, balance of trade effect, and interest rate effect. The components of aggregate demand include consumer spending, investment spending, government spending, and net export spending, calculated using the formula AD = C + I + G + X - M. Shifts in the AD curve occur due to changes in these components, indicating higher or lower demand at each price level.

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48 views4 pages

Understanding Aggregate Demand in Macroeconomics

Aggregate demand (AD) measures the total demand for final goods and services in an economy, represented by the AD curve, which slopes downward due to the real income effect, balance of trade effect, and interest rate effect. The components of aggregate demand include consumer spending, investment spending, government spending, and net export spending, calculated using the formula AD = C + I + G + X - M. Shifts in the AD curve occur due to changes in these components, indicating higher or lower demand at each price level.

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adriennea194
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THE CLASSICAL MODELS OF THE MACROECONOMY

Aggregate Demand
Aggregate demand (AD) is a measurement of the total amount of demand for all final goods

and services produced in an economy. Aggregate demand is expressed as the total amount of

money exchanged for those goods and services at a specific price level and point in time.

NB:

● The AD Curve shows us the level of real GDP that is purchased by economics agents

(firms, government, households) at different price levels during a specific time period

(usually one year).

● Inverse Relationship between real GDP and Price Level

● Downward sloping curve

● There is a movement along the AD curve because the price level has changed (Price level

factor Determinant of AD)

1
THE CLASSICAL MODELS OF THE MACROECONOMY

Why does the aggregate demand curve slope downwards from left to right?

● Real income effect: As the price level falls, the real value of income rises, and

consumers can buy more of what they want or need – this is known as the real money

balance effect. Therefore real GDP will rise.

● Balance of trade effect: A fall in the relative price of level of Country X could make

foreign-produced goods and services more expensive, causing a rise in exports and a

fall in imports. Exports are an injection, imports a withdrawal. Therefore Real GDP will

rise.

● Interest rate effect: If inflation is low, this might lead to a reduction in interest rates by

the central bank. Lower interest rates means there is less incentive to save and a fall in

interest rates may cause the exchange rate to depreciate and improve exports. Therefore

Real GDP will rise.

Components of AGGREGATE DEMAND

Aggregate demand is computed as follows,

AD = C+ I+ G + X - M

NOTE: This formula is identical to calculating the GDP using the expenditure approach.

2
THE CLASSICAL MODELS OF THE MACROECONOMY

The Factors that Influence Aggregate Demand

1) Consumer spending

2) Investment spending

3) Government spending

4) Net export spending

3
THE CLASSICAL MODELS OF THE MACROECONOMY

Shifts in the Aggregate Demand curve

Shifts in the aggregate demand curve are caused by factors independent of changes in the
general price level. These included changes in C, I, G, X, M.

An outward shift of AD means a higher level of demand at each price level. One or more of
the components of AD must have changed. AD1 shifts to AD2.

An inward shift of AD means that total expenditure (demand) on goods and services at each
price level has fallen. AD1 shifts to AD3.

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