Aggregate Demand is the relationship between the aggregate price level and the quantity of output. AD is similar to the law of demand that already exists but the factors that affect AD are slightly different than demand. The factors that affect AD are household consumption, government spending, investment, and net exports. It is important to note that AD is the same in both the short run and the long run. Aggregate Demand represents how a change in a certain price level will change expenditures on all services and goods in an economy. There are several components that make up AD and explain how it works. These are:
- The Effects of Price on Aggregate Demand
- Other Factors Besides Price Effecting Aggregate Demand
- The Multiplier Effect
Aggregate Demand Curves
Two specific AD representations are useful to consider:
- Keynesian Cross: The Keynesian Cross is a simple illustration of the relationship between aggregate demand and desired total spending (linear at 45 degrees). The intersecting AD line will generally have an upwards slope, under the assumption that increased national output should result in increased disposable income.
- Aggregate Demand/Aggregate Supply Model (AD/AS):The x-axis represents the overall output, while the y-axis represents the price level. The aggregate quantity demanded (Y = C + I + G + NX) is calculated at every given aggregate average price level.
According to Keynesian demand-side theory, future economic production is propelled by money spent on goods and services. British economist John Maynard Keynes considered unemployment to be a byproduct of insufficient aggregate demand, because wage prices would not adjust downward fast enough to compensate for reduced spending. He believed government could spend money and increase aggregate demand until idle economic resources, including laborers, were redeployed. The Keynesian equation for aggregate demand is: AD = C+I+G+(Nx) Where: C = Consumer spending I = Private investment spending for non-final capital goods G = Government spending Nx = Net exports
Aggregate demand and the circular flow
Aggregate demand can be illustrated by reference to the circular flow of income (figure below):
source: Economics Online
Austrian theorist Henry Hazlitt argued that aggregate demand is "a meaningless concept" in economic analysis. Friedrich Hayek, another Austrian, wrote that Keynes' study of the aggregate relations in an economy is "fallacious," arguing that recessions are caused by micro-economic factors.