What is Demand?

In economic terms, demand can be defined as the need for a product/service that is arrived in the market at a specific period by certain consumers. They can pay any value for the product/service that is demanded by the consumer at that time.

In the above image, it is clear that demand is downward sloping.

Demand Curve 

In economic terms, the demand curve states that when the price level of the product/service changes, its demand also gets affected. Therefore, if the price level of the product increases, the demand for that product with be decreased, which will shift the demand curve from left to right, and if the price level decreases, the demand increases that will shift the demand curve right to left.

Aggregate Demand Curve 

Aggregate Demand Curve measures the cost of all the products/services that are demanded by the consumers and manufactured in the country. Aggregate Demand Curve is the total price paid in buying those products/services produced during a time at some price level.

Aggregate Demand Curve can be measured by using the below formulae:

 AD = C+I+G+(X-M)

 Where, 

• AD is the Aggregate Demand
• C is the consumption
• I is the investment
• G is the Government Spending
• X is the total exports
• M is the total imports.

Now we can briefly understand the above equation.

Consumption Function 

In economics, it refers to the connection between total consumption and gross national income (GNP) of the economy. This concept was given by the economist John Maynard Keynes. It can be represented by the equation: C = C + bY, where C is the consumption, Y is the given level of income, and b is the times of a given level of income.

Investment Function

In economics, it refers to all the variables that will affect the levels of aggregate investments in the economy. The rate of interest is one of the variables of investment function as when the interest rates are increased, then the investments will fall, and when the interest rate is decreased, then the investment level will rise.

Government Spending

In economics, government spending refers to the spending on the purchase of products/services and providing the services such as health, education, and money spent on defense for the protection of the general public by the government bodies. The taxes paid by the public is the main source of income for the governments, and they invest that money in providing education facilities, health facilities, and technological advancement to the public.

Net Exports

In economics, it refers to the total products/services which a country exports to other nations minus the products/services which a country imports from other countries. It is included in calculating the GDP (Gross Domestic Product) of the economy.

Factors that Affect Aggregate Demand

The interest rate goes change- when the rate of interest is increased, then the borrowings of the companies get decreased, and the price level of the products will rise, which will make the consumers spend less on the products.

Income and Wealth- When the income of the people increases, AD will also rise and vice-a-versa. With the rise in income, people will likely save more will leads to less demand for the products/services.

Inflation- When there is inflation in the economy and prices for the products/services are also rising, then the AD for buying the commodities will also rise, but if inflation causes a fall in the prices of the commodities, then the AD will also decrease. In economic and financial terms, the word inflation refers to the increase in the price level of products/services of daily or common use like food, consumer staples. It is the decrease in the purchasing power of currency over time.

Change in the exchange of Currency rates- When the price of U.S. dollars falls, then the products/services produced in the United States will become cheaper in the market, and the AD for buying home country commodities will fall. In economics and financial terms, the exchange rate refers to the price of a currency in terms of another country's currency. Exchange rates always fluctuate from low to high or high to low depending on the demand and supply in the economic market.

Limitations of Aggregate Demand

• It does not show the standard of living of the people of the economy.
• It will not determine the factors that affect the demand in the economy.

How is equilibrium affected when there is AD?

When prices of the commodities rise in the economy, it gives the manufacturers the idea of manufacturing the commodities, and the cost of commodities supplied is more than the AD. As the cost of commodities increases, aggregate supply will rise, and AD will decrease till it reaches the equilibrium price.

What is Supply?

In economic terms, supply can be defined as the readiness of the manufacturer to manufacture the products/services in the market. The supply of the products/services is directly related to its price level as if the price level is increased, and then its supply will be increased. The increase in the price level of the products/services will give more profits to the manufacturers.

In the above image, the supply graph is upward sloping which means with the increase in the price level, the supply of the commodities also increases.

What is Aggregate Supply (AS)?

In an economy, the aggregate supply is defined as the total supply of the products/services which the manufacturers are ready to sell in the market at a given cost at a particular time.

In the short run, aggregate supply can be calculated as below

Y=Y*+α(P-Pe)

Where,

• Y is the total production in the economy
• Y* is the natural level of production in the economy
• α is always greater than zero
• P is the price level
• Pe is the price level that consumer expects.

The manufacturers decide on the amount of quantity supplied of their commodities based on their revenue generated from the selling of earlier commodities. The revenue generated helps them to make the cost analysis of their commodities as well as the cost being used in the inputs like the purchase of raw materials, remuneration to the labors, etc., and accordingly, they charge for the commodities from the consumers in the market. The aggregate supply curve will depict the total quantity of the commodities produced (real GDP) that the manufacturers will sell at each price level.

What is the Aggregate Supply Curve?

In macroeconomic terms, the supply curve refers to the cost of the product/service and the quantity supplied within a given time. When the price level of a commodity increase, the producers assumes that the quantity supplied will also increase as they can collect more income from the more quantity supplied. The supply curve will shift upward when the prices are increased. 

Long-run Aggregate Supply Curve (LRAS)

In the long run, the supply curve is vertical and shows the output level will remain the same even if the price level changes in the economy. 

Factors that affect the Long-run Aggregate Supply (LRAS)

Factors affecting the supply curve in the long run are:

• Availability of land and raw materials.
• The quantity and productivity of labor.
• The quantity and productivity of capital.
• The use of technological equipment will affect the production and output of the commodities.

Short-run Aggregate Supply (SRAS)

In the short run, the companies can make changes in the variable factors of production such as labor as the capital of the company is fixed. In the short run, the companies can make changes in the production level of the commodities by increasing or decreasing the labor. In the short run, the supply curve is upward sloping and shows a positive relationship between the product price and quantity supplied at different instances of time. 

Factors that affect the short-run Aggregate Supply (SRAS)

• The cost of raw materials.
• Changes in the salaries/wages of the laborers.
• Change in the government tax policies.

Points to be noted about SRAS

• SRAS is also known as the upward-sloping AS curve, which depicts the direct connection between the price level and real GDP.
• When the cost of inputs in the SRAS curve remains fixed, but manufacturers can change the price level of the output, which will give them high-profit margins.
• The AD curve is downward sloping depicts the connection between the cost of the outputs and the quantity of amount spent in an economy.
• The potential GDP in an economy refers to the maximum amount of commodities it can produce by employing the labors, capital, and technology to the full extent.
• In macroeconomic, the AD and AS curves intersect at a point where the total quantity supplied equals the total quantity demanded in the economy. It is known as the equilibrium level in the economy.

Points to be noted about Aggregate Demand and Aggregate Supply Curve

• It will help them to know about employment opportunities in the future.
• It will incorporate growth in the economy.
• When the AD curve shifts rightwards, it will increase the GDP.
• When the Aggregate Supply curve rises upwards, it will increase the output level.
• The economy will grow if the quantity and quality of the factors of production are increased.

Context and Applications

This topic is significant in the professional exams for both undergraduate and graduate courses, especially for

• B.A (Economics Hons)
• M.A (Economics Hons)