Aggregate Demand Curve

What is the Aggregate Demand Curve?

Definition: The aggregate demand curve is a economic graph that indicates how many goods and services households, firms, and the government are willing and able to buy.

The aggregate demand curve represents the total quantity of all goods (and services) demanded by the economy at different price levels.

Aggregate Demand Curve
Aggregate Demand Curve

The vertical axis represents the price level of all final goods and services. The aggregate price level is measured by either the GDP deflator or the CPI. The horizontal axis represents the real quantity of all goods and services purchased as measured by the level of real GDP. Notice that the aggregate demand curve, AD, like the demand curves for individual goods, is downward sloping, implying that there is an inverse relationship between the price level and the quantity demanded of real GDP.

What Does Aggregate Demand Curve Mean?

What is the definition of aggregate demand curve? The aggregate demand curve is the sum of all the demand curves for individual goods and services. Therefore, as the individual demand curve, it is downward sloping, representing an opposite relationship between the price and the quantity demanded. Higher prices lower the disposable income, and, thereby, consumption.

Conversely, lower prices increase the disposable income of consumers who spend more, save more, and invest more. Furthermore, lower interest rates lower the prices of goods and services, thereby increasing consumption and saving. The ADC shifts when a change in demand, government spending, investments, or net exports takes place.

Example

Three main factors affect the aggregate demand curve, causing it to be downward sloping: the supply of money, the interest rates, and the next exports.

Consumers tend to believe that a nation’s government is able to keep the supply of money intact. Therefore, when the general price level rises, the supply of money to the economy loses its value, meaning the purchasing power of consumers diminishes. As consumers have less money to spend, the demand for goods and services decreases as well. Conversely, when the general price level decreases, the purchasing power of consumers increases. As consumers have more money to spend, the demand for goods and services increases.

The same happens with the interest rates. As the general price level rises, consumers and businesses require more money to spend. However, as the supply of money to the economy remains intact, the interest rates rise, causing consumer spending to decline.

Finally, when the prices of domestic goods and services increase, the imported goods are cheaper, thereby increasing the demand for imports and lowering the demand for exports. As a result, the net exports of the economy decrease, causing a respective decrease in the nation’s GDP.

Summary Definition

Define Aggregate Demand Curve: ADC means a graph showing the overall demand for goods and services of an economy.

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