4.3 Aggregate Demand and Aggregate Supply Analysis

2026 Syllabus Objectives

By the end of this topic, you should be able to:

  1. Define Aggregate Demand (AD)
  2. Identify and explain the components of AD: AD = C + I + G + (X – M)
  3. Explain the determinants of AD
  4. Explain why the AD curve is downward sloping
  5. Explain the causes of a shift in the AD curve
  6. Define Aggregate Supply (AS)
  7. Explain the determinants of AS
  8. Describe the shape of the AS curve in the short run (SRAS) and the long run (LRAS)
  9. Explain the causes of shifts in SRAS and LRAS
  10. Distinguish between a movement along and a shift in AD and AS curves
  11. Explain how equilibrium is established in the AD/AS model
  12. Analyse the effects of shifts in AD and AS on real output, price level, and employment

Main Content

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1. What is Aggregate Demand (AD)?

Aggregate Demand (AD) is the total spending on goods and services in an economy during a given time period. Think of it as adding up everything that everyone — households, businesses, the government, and foreign buyers — spends on the goods and services produced in a country.

The word "aggregate" simply means "total" or "combined."

2. Components of AD: AD = C + I + G + (X – M)

AD has four parts. Together they make up the formula:

AD = C + I + G + (X – M)

Let's look at each component:

C — Consumption This is the spending by households (ordinary people) on goods and services — things like food, clothes, phones, and haircuts. It is usually the largest part of AD in most economies.

I — Investment This is spending by firms (businesses) on capital goods — things like machinery, equipment, factories, and new technology. Investment helps businesses grow and produce more in the future.

G — Government Spending This is money spent by the government on public goods and services — for example, building roads, paying teachers' salaries, funding hospitals, and running the police force. This does not include transfer payments like welfare benefits (money given to people without buying a good or service in return).

(X – M) — Net Exports

  • X = Exports: goods and services sold to other countries. Foreign buyers spending money on our products adds to our AD.
  • M = Imports: goods and services bought from other countries. When we buy imports, that money leaves our economy, so it reduces AD.
  • (X – M) is also called Net Exports (NX). If exports are greater than imports, net exports are positive and boost AD. If imports are greater than exports, net exports are negative and reduce AD.

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