What is Aggregate Demand?

Aggregate demand (AD) represents the total quantity of goods and services demanded across all levels of an economy at a given time and price level. This concept assists economists in understanding the overall demand in the economy, hence helping them assess levels of economic growth, typically represented by the Gross Domestic Product (GDP).

What are the Components of Aggregate Demand?

Aggregate demand consists of four main components, often remembered by the acronym CIGX:

Consumption (C)

Consumption is typically the largest component of aggregate demand, often accounting for around 60-70% of GDP in developed economies. In Australia, household consumption accounted for 49.65% of GDP in 2023. This low level of consumption reflects a shift in spending, in light of economic recovery from Covid-19, which caused high inflation and interest rates.

Investment (I)

Investment refers to the expenditure on capital goods that will be used for future production. It includes business investments in equipment, infrastructure, and residential construction. In Australia, gross fixed capital formation (GFCF) accounted for 23.02% of GDP in 2022, up from 22.2% in 2020. Additionally, this can be attributed to Australia's quick economic recovery, which saw the stabilisation of Australia's economy, boosting business and investor confidence, thus attracting foreign investment.

Government Expenditure (G)

Government spending encompasses all government expenditures on goods and services. It includes spending on infrastructure, education, healthcare, and defence. This component is directly controlled by government policies to ultimately manipulate the overall demand in the economy. For example, the Australian government provided approximately $314 billion in stimulus packages during the COVID-19 pandemic to boost aggregate demand through increased government spending.

Net Exports (X-M)

Net exports represent the balance between a country's exports and imports. A positive value indicates a trade surplus, while a negative value indicates a trade deficit. In 2022, Australia's net exports contributed positively to aggregate demand due to a strong mining sector and high demand for commodities like iron ore and coal. Most of this demand came from the re-opening of Chinese manufacturing services.

The Aggregate Demand Formula

Now that we know about the components of aggregate demand (AD), we can explore its formula. The formula for the total aggregate demand in an economy is:

$$AD=C+I+G+(X-M)$$

This equation shows how changes in any component will affect the overall aggregate demand. For example, if consumption increases while other components remain constant, aggregate demand will increase by the same amount.

Can you Graphically Represent Aggregate Demand?

Using an aggregate demand vs aggregate supply graph can be an extremely effective way of demonstrating the effects of increases/decreases in aggregate demand on an economy. To find out how to integrate these graphs and arguments into your HSC economics essays, check out our article specifically about Supply vs Demand Graphs

How does AD Affect Economic Growth?

To determine how shifts in aggregate demand affect economic growth, we must first realise that sustained economic growth requires a balance between aggregate demand and aggregate supply. If aggregate demand grows too quickly relative to the economy's productive capacity, it can lead to inflation and other economic imbalances.

Generally, when aggregate demand decreases, it leads to lower rates of economic growth. However, more importantly, when aggregate demand increases, it leads to higher economic growth through several mechanisms: