Aggregate Demand and Aggregate Supply

To explain movements in output, prices, and employment together, economists use the AD–AS model, plotting the general price level on the vertical axis against real national output on the horizontal axis.

Aggregate demand

Aggregate demand (AD) is the total planned spending on domestic goods and services at each price level, made up of the same four components as expenditure GDP:

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

The AD curve slopes downward for three reasons. The wealth effect: a lower price level raises the real value of money holdings, so people feel richer and spend more. The interest-rate effect: lower prices reduce the demand for money, lowering interest rates and encouraging borrowing and investment. The net-export effect: lower domestic prices make exports more competitive abroad, raising