Aggregate demand

In economics, aggregate demand (AD) or domestic final demand (DFD) is the total demand for final goods and services in an economy at a given time.^[1] It is often called effective demand, though at other times this term is distinguished. This is the demand for the gross domestic product of a country. It specifies the amount of goods and services that will be purchased at all possible price levels.^[2] Consumer spending, investment, corporate and government expenditure, and net exports make up the aggregate demand.

The aggregate demand curve is plotted with real output on the horizontal axis and the price level on the vertical axis. While it is theorized to be downward sloping, the Sonnenschein–Mantel–Debreu results show that the slope of the curve cannot be mathematically derived from assumptions about individual rational behavior.^[3]^[4] Instead, the downward sloping aggregate demand curve is derived with the help of three macroeconomic assumptions about the functioning of markets: Pigou's wealth effect, Keynes' interest rate effect and the Mundell–Fleming exchange-rate effect. The Pigou effect states that a higher price level implies lower real wealth and therefore lower consumption spending, giving a lower quantity of goods demanded in the aggregate. The Keynes effect states that a higher price level implies a lower real money supply and therefore higher interest rates resulting from relevant market equilibrium condition, in turn resulting in lower investment spending on new physical capital and hence a lower quantity of goods being demanded in the aggregate.

The Mundell–Fleming exchange-rate effect is an extension of the IS–LM model. Whereas the traditional IS-LM Model deals with a closed economy, Mundell–Fleming describes a small open economy. The Mundell–Fleming model portrays the short-run relationship between an economy's nominal exchange rate, interest rate, and output (in contrast to the closed-economy IS–LM model, which focuses only on the relationship between the interest rate and output).

The aggregate demand curve illustrates the relationship between two factors: the quantity of output that is demanded and the aggregate price level. Aggregate demand is expressed contingent upon a fixed level of the nominal money supply. There are many factors that can shift the AD curve. Rightward shifts result from increases in the money supply, in government expenditure, or in autonomous components of investment or consumption spending, or from decreases in taxes.

According to the aggregate demand-aggregate supply model, when aggregate demand increases, there is movement up along the aggregate supply curve, giving a higher level of prices.^[5]

^ Sexton, Robert; Fortura, Peter (2005). Exploring Economics. ISBN 0-17-641482-7. This is the sum of the demand for all final goods and services in the economy. It can also be seen as the quantity of real GDP demanded at different price levels.
^ O'Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey: Prentice Hall. p. 307. ISBN 0-13-063085-3. Archived from the original on 2016-12-20. Retrieved 2020-11-05.
^ Sonnenschein, Hugo; Shafer, Wayne (1982). "Chapter 14 Market demand and excess demand functions". In Arrow, Kenneth J.; Intriligator, Michael D. (eds.). Market demand and excess demand functions. Handbook of Mathematical Economics. Handbook of Mathematical Economics. Vol. 2. pp. 671–672. doi:10.1016/S1573-4382(82)02009-8. ISBN 9780444861276. The importance of the above results is clear: strong restrictions are needed in order to justify the hypothesis that a market demand function has the characteristics of a consumer demand function. Only in special cases can an economy be expected to act as an 'idealized consumer.' The utility hypothesis tells us nothing about market demand unless it is augmented by additional requirements.
^ Chiappori, Pierre-André; Ekeland, Ivar (1999). "Aggregation and Market Demand: An Exterior Differential Calculus Viewpoint". Econometrica. 67 (6): 1437. doi:10.1111/1468-0262.00085. JSTOR 2999567. ...we establish that when the number of agents is at least equal to the number of goods, then any smooth enough function satisfying Walras's Law can be locally seen as the aggregate market demand of some economy, even when the distribution of income is imposed a priori.
^ Mankiw, N. Gregory, and William M. Scarth. Macroeconomics. Canadian ed., 4th ed. New York: Worth Publishers, 2011. Print.

[1] Sexton, Robert; Fortura, Peter (2005). Exploring Economics. ISBN 0-17-641482-7. This is the sum of the demand for all final goods and services in the economy. It can also be seen as the quantity of real GDP demanded at different price levels.

[2] O'Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey: Prentice Hall. p. 307. ISBN 0-13-063085-3. Archived from the original on 2016-12-20. Retrieved 2020-11-05.

[sonnenschein-shafer-3] Sonnenschein, Hugo; Shafer, Wayne (1982). "Chapter 14 Market demand and excess demand functions". In Arrow, Kenneth J.; Intriligator, Michael D. (eds.). Market demand and excess demand functions. Handbook of Mathematical Economics. Handbook of Mathematical Economics. Vol. 2. pp. 671–672. doi:10.1016/S1573-4382(82)02009-8. ISBN 9780444861276. The importance of the above results is clear: strong restrictions are needed in order to justify the hypothesis that a market demand function has the characteristics of a consumer demand function. Only in special cases can an economy be expected to act as an 'idealized consumer.' The utility hypothesis tells us nothing about market demand unless it is augmented by additional requirements.

[chiappori-ekeland-4] Chiappori, Pierre-André; Ekeland, Ivar (1999). "Aggregation and Market Demand: An Exterior Differential Calculus Viewpoint". Econometrica. 67 (6): 1437. doi:10.1111/1468-0262.00085. JSTOR 2999567. ...we establish that when the number of agents is at least equal to the number of goods, then any smooth enough function satisfying Walras's Law can be locally seen as the aggregate market demand of some economy, even when the distribution of income is imposed a priori.

[Mankiw,_N._Gregory_2011-5] Mankiw, N. Gregory, and William M. Scarth. Macroeconomics. Canadian ed., 4th ed. New York: Worth Publishers, 2011. Print.

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