Syllabus points
- Define and explain the components of aggregate demand (AD).
- Explain the shape of, and shifts in, the AD curve.
- Distinguish short-run aggregate supply (SRAS) from long-run aggregate supply (LRAS).
- Explain equilibrium and the Keynesian vs monetarist/new-classical models.
Aggregate demand
Aggregate demand is total planned spending on domestic output at each price level: AD = C + I + G + (X − M).
| Component | Key influences |
|---|---|
| Consumption (C) | Income, confidence, interest rates, wealth |
| Investment (I) | Interest rates, business confidence, technology |
| Government (G) | Fiscal policy, the economic cycle |
| Net exports (X − M) | Exchange rates, foreign income, competitiveness |
The AD curve slopes downward because a lower price level raises real wealth (wealth effect), lowers interest rates (interest-rate effect), and makes exports more competitive (international-trade effect). A change in any component shifts AD.
Aggregate supply
- SRAS slopes upward: with money wages fixed, a higher price level raises firms' profit margins and output. It shifts with input costs (wages, raw materials, exchange rates) and indirect taxes.
- LRAS shows the economy's productive potential. In the monetarist/new-classical view it is vertical at full-employment output (Yf); in the Keynesian view it has a horizontal section at low output, a curved middle, and a vertical section at capacity.
Macroeconomic equilibrium
Equilibrium occurs where AD = AS, determining the real output and price level. A rise in AD raises both output and the price level when the economy is below capacity; near capacity it mainly raises prices. The size of the output effect depends on which section of the LRAS the economy is on — the central debate between Keynesian and new-classical economists.
Worked example
Suppose investment falls due to a loss of business confidence. AD shifts left, reducing equilibrium real output and the price level. On a Keynesian AS curve with spare capacity, most of the fall is in output (rising unemployment); near full employment, more of the adjustment falls on prices.
Common exam mistakes
- Confusing a movement along AD (price-level change) with a shift (change in a component).
- Forgetting that SRAS and LRAS respond to different factors.
- Treating the LRAS shape as settled — always note the Keynesian vs new-classical distinction.
Exam technique
Draw and label AD–AS diagrams accurately, state the direction of the shift and the cause, and evaluate the output-vs-price outcome according to the position on the AS curve.
Quick revision
- AD = C + I + G + (X − M); downward-sloping via wealth, interest-rate and trade effects.
- SRAS upward-sloping (costs); LRAS vertical (new-classical) or kinked (Keynesian).
- Equilibrium at AD = AS sets real output and price level.
- Output vs price outcome depends on spare capacity.