Aggregate demand (also referred to as just AD) is the total demand for final goods and services in the economy (represented by the Y on a graph) at a given time and price level. In other words, AD is the demand for the gross domestic prodcut of a country when inventory levels are static. AD is represented by the equation where Yd= C+I+G+(X-M). This linear representation of the AD shows us that the AD is separated into four distinct sectors. The first sector that makes up the AD is the C.
The C represents the consumer’s expenditure on goods and services. Basically, this sector takes into account the personal spending and demand by households and unattached individuals. The determination of this sector is described by the consumption function where C= a + (mpc)(Y-T). In this equation a equals the autonmous consumption, mpc equals the maginal prpensity to consume and (Y-T) equals the disposalbe income of the consumer. The second sector that makes up the AD is the I.
The I represents the gross private domestic investment. In other words, the invenstment that companies in the given economy are spending on capital goods. Investment includes money that companies spend on working capital such as stocks of finished goods as well as works in progress. A good exampl of this idea is the money that a company might invest in to build a new factory to manufacture their goods. The third sector that makes up the AD is the G. The G represents the gross government expenditure and investment.
In other words, the money that the government spends on publicly provided goods and services including public and merit goods. Transfer payments in the form of such things like social security payments (i. e. pensions, job seeker allowances) are not included because they are not a payment to a factor of production for output produced. The fourth sector that makes up the AD is the X-M (though at times it can also be represented as NX in some linear equations of AD). The X-M represents the net exports of goods and services for a country.
In the linear equation it is important to note that the X represents the total exports of the country and the M represents the total imports of the country. Together, the two give a better picture of what the net demand the rest of the world is for a country’s output (Miller, 1997). The actions of each group and how they influence the AD is best shown on a Aggregate Demand Curve. An Aggregate Demand Curve takes all the variables that make up the AD and expresses it in graph form. In looking at the AD Curve, economists see that all the variables play a part in influencing the AD.
For example, if there is a high consumer demand for a product then there will be a rise in disposable income which in turn increases the total national output. Aggregate demand may also rise due to increases in investment. Equilibrium of the AD curve is achieved when total demand for a product equals total supply. As any of the components of aggregate demand rises at each level of income, for example because business becomes more optimistic about future profitability, that shifts the entire AD line upward.
This raises equilibrium income and output. Similarly, if the elements of AD fall, that shifts the line downward and lowers equilibrium output (Miller, 1997). Aggregate Supply is the total supply of goods and services produced by a national economy during a specific time period. On a graph the Aggregate Supply line (also known as the Z curve) represents the total amount of production that corresponds to the total amount of income in a country during a specific time period (Miller, 1997).