From microeconomics we know that individuals and firms have demand curves for
goods and services. But what happens when you try to get a picture of the
demand for goods and services for the entire economy? While this task may at
first seem daunting, there is a relatively simple way to perform it by using the
aggregate demand curve. The aggregate demand curve represents the total
demand for goods and services in an economy. By defining the aggregate demand
curve in terms of the price level and output or income, it is
possible to analyze the effects of other variables, like the interest rate, on
aggregate demand through the aggregate demand equation.
But, aggregate demand is only half of the view of the economy that we have been
building up to in macroeconomics. The other half of this view, aggregate
supply, was covered in the following SparkNote on Aggregate
Supply. For now, we will focus on the basics
of aggregate demand. We will work through why the aggregate demand curve is
downward sloping. We will also catch a glimpse of how the aggregate demand
curve is derived. Finally, we will see how the aggregate demand curve shifts
when economic variables change the aggregate demand.
By understanding the basics of aggregate demand as presented in this section,
you will be preparing yourself for the big picture of the macroeconomy that
follows when aggregate demand and aggregate supply are combined. This allows
policies and economic changes to be evaluated in a highly realistic model.
Through the combined aggregate supply aggregate demand, or AS-AD, model,
macroeconomic theory approaches macroeconomic reality. In this way, the AS-AD
model is the centerpiece of evaluating macroeconomic policy decisions.
