BACK BY AGGREGATE DEMAND
Aggregate Demand (AD) is an insanely important concept in macroeconomics that you absolutely have to get a handle on. I demand it. 🤓 Aggregate Demand refers to the total spending in an economy. It's all the demand curves of every market combined into one big curve, but instead of just showing one product, it shows the demand for everything—all goods and services produced in a country.
AD is what drives the economy forward, and without it, nothing gets sold 🛒 nobody gets paid, and the whole system grinds to a very depressing (or at least recessing 📉 ) halt.
The Link Between AD and GDP
Here’s the big deal: Aggregate Demand equals Nominal GDP. That’s right, they’re basically twins. Why? Because Nominal GDP measures the total spending 💸 on goods and services in an economy at current prices, and that’s literally what AD is.
But wait—there’s a small twist: the x-axis of the AD model represents Real GDP, not Nominal GDP. That’s because we adjust for inflation to show the actual quantity of goods and services, rather than just their price tags.
So, you can think of Aggregate Demand as the spending side 💵 of the economy, while Real GDP is the output side 🏭 . They’re two sides of the same coin—one is what we spend, and the other is what we produce.
Which leads us to a key economic principle: spending = output. Why? Because when you buy something, you’re paying for the work someone else has done. It’s like taking coins from your right pocket and putting them in the cashier's pocket—what’s spent by one person is earned by another. But really the cashier should put the coins in the cash register and you should keep your hands to yourself.
Fun Fact: AD refers to the total spending in an economy and since that's at current prices AD also represents the nominal GDP. Wooh!
The Four Components of AD
Aggregate Demand is made up of four big spending categories. Together, they tell us where all those dollar bills are going:
🏠 Consumption (C): This is what households spend on goods and services—everything from groceries to Netflix subscriptions to the year's supply of McNuggets your eccentric friend keeps in the freezer. It’s the largest chunk of AD because, people like to spend and usually on consumer goods.
Further examples of consumer spending include: avocado toast, pokemon cards, colorful socks, not so colorful socks, lawn mowers, baseball caps, golf balls, cosmetics, app subscriptions, maple syrup, and a sturdy pair of jeans. However note the difference between jeans and maple syrup. Jeans are a durable good, while maple syrup is a non-durable. A durable is something you get to consume more than once and presumably you wear the same jeans over a few times. Perhaps many days in a row depending on your personal level of hygiene.
🏢 Investment (I): Investment means business spending on things like new factories 🏭 machinery and equipment 🚜 (and weirdly houses which you might think count as part of household spending but nope they're investment spending because they’re considered part of new production.) 🏗🏠 It’s all about building stuff that helps the economy grow in the future: capital goods - the goods used to make other goods.
Examples of investment spending include: new computers, uniforms, new home construction, business cards, billboards, printers, office furniture, conveyor belts, cattle ranch fences, cotton candy machines, sumo wrestling mats, brewery tanks, escape room props, roller coaster tracks, bowling alley lanes, aquarium tanks, chainsaws, pottery kilns, arcade machines, greenhouse equipment, tattoo guns, karaoke systems, ice cream trucks, hot air balloons, and alpaca shearing tools and of course microsoft office. Basically, anything a business buys to make their operations smoother, their employees happier, or their profits bigger counts as investment spending—well, as long as it helps create future goods and services.
Ok, be careful! The economic definition of investment isn’t (directly) about buying stocks or bonds or crypto. In the economic context investment simply means purchases made by firms not the movement of money through stock or bond market transactions. However companies that sell stock (which you invest in) use that money on business spending so the economic definition of investment ultimately does match the plain English definition of investment. We don't count stock purchases as investment spending, but we do count that money when its used to make purchases (otherwise we'd be double counting).
🏛 Government Spending (G): This is what the government shells out on goods and services. Anything from the purchases of pencil sharpeners at your county clerk office to the POTUS's favorite choice of ice cream.
Examples include: roads, bridges, parks, ports, power grids, police and fire stations, hospitals and hospital beds, garbage trucks, colleges, kindergartens, textbooks, the class bunny 🐰 and of course military equipment, helmets, rockets 🚀 javelins, and other weapons of war. Anything the government purchases involves someone who produces that good or service. Wow, who knew the government could actually make the world a better place! 🤭
But here’s a key point: transfer payments don’t count. That means things like unemployment benefits or pensions don’t show up in AD because they’re just redistributing money, not creating new output - they aren't creating production. Only government purchases count. Nukes? Yes. Classroom bunnies? Yes. Consumption vouchers and Social Security payments? Nope. Just like with stock market transactions, we want to avoid double counting.
🚢 Net Exports (X - M): This is exports (X) minus imports (M). We count exports because they’re produced here (wherever here is... 🇺🇸? 🇭🇰? 🇵🇦? ), but we subtract imports because they’re made elsewhere. So, if you’re buying a 👕 t-shirt made in 🇧🇩 Bangladesh, that’s not part of our AD—it’s Bangladesh's. Unless you're already in Bangladesh in which case we need another example.
Some real world examples of exports and imports include: Japanese cars, Alberta beef, Hong Kong insurance, Malaysian rubber, Saudi oil, Hawaiian coffee, French wine, Swiss cheese and of course German cynicism.