Demand curves in microeconomics show what people want to buy of one good. Aggregate demand does the same job for an entire economy at once: everything, by everyone, at every price level. It has four parts, one downward sloping curve, and one distinction that students lose marks on constantly.
📘 What you need to know
Aggregate demand (AD) is total planned spending on a country’s goods and services at each average price level.
AD = C + I + G + (X − M). The same four components as the expenditure method for GDP.
The AD curve is downward sloping: a lower average price level goes with more real output demanded.
A change in the average price level causes a movement along the curve.
A change in anything else causes the whole curve to shift.
The axes are average price level (vertical) and real GDP (horizontal). Y is the usual symbol for real GDP.
Consumption is by far the biggest component, so anything that moves C moves the whole economy.
New machinery, factories, vehicles, software, buildings
G — government spending
The government
Teachers’ salaries, hospitals, defence, roads, public services
X − M — net exports
Foreigners minus us
Export revenue earned, minus spending on imports
Rough shares for a typical advanced economy. The exact split varies a lot between countries, so use the figures a data question gives you rather than these.
Those proportions matter more than students realise. If consumption is roughly 60% of AD and net exports are roughly 1%, then a 1% rise in consumption does about sixty times as much for AD as a 1% rise in net exports. When a question asks which policy will have the biggest effect, the size of the component is often the answer.
Country differences are worth knowing. Government spending is a much bigger share of AD in high-tax Nordic economies than in the United States. Net exports are hugely important to export-driven economies and tiny in large domestic economies. Never assume one set of shares applies everywhere.
The AD curve and why it slopes down
The AD curve has real GDP on the horizontal axis and the average price level on the vertical. Lower average price level, more real output demanded. Higher average price level, less.
Be careful with the reasoning here, because it is not the same as for a single good. With one good, a price rise makes people switch to substitutes. With the whole economy, there is nothing to switch to. Three different explanations do the work:
Real wealth. A higher price level means the money people already hold buys less, so they feel poorer and spend less.
Interest rates. Higher prices mean people need more money for the same transactions, which tends to push interest rates up, discouraging borrowing for consumption and investment.
International competitiveness. If domestic prices rise while foreign prices do not, exports become dearer abroad and imports look cheaper at home, so net exports fall.
Movements along the curve
Only the average price level has changed here. The curve itself has not moved at all, so the economy simply slides along it.
Price level rises from AP1 to AP2: movement from A to B, and real GDP demanded contracts from Y1 to Y2.
Price level falls from AP1 to AP3: movement from A to C, and real GDP demanded expands from Y1 to Y3.
🧩 The test that decides movement or shift
Ask what changed. Write it down in a few words.
Was it the average price level? If yes, it is a movement along the curve. Use the words expansion or contraction.
Was it anything else at all? Consumer confidence, interest rates, taxes, government spending, exchange rates, incomes abroad. If yes, the whole curve shifts.
Say which direction and why. “Confidence falls, so C falls, so AD shifts left” is the sentence that earns marks.
Here is a trap worth knowing. If a question says inflation has risen, that is the average price level, so it is a movement. If a question says the government cut income tax, that is not a price level change at all, so the curve shifts. Read the trigger carefully before you draw anything.
A quick note on the components
Two definitions cause repeated trouble, so nail them now.
Investment means firms buying capital goods. It does not mean buying shares or putting money in a savings account. In everyday speech those are investments. In economics they are not.
Government spending excludes transfer payments. Pensions and benefits move money between people without producing anything. They show up later in consumption, when the recipient spends them.
WORKED EXAMPLE
An economy reports, in $ billions: consumption 620, investment 180, government spending 240, exports 190, imports 230, state pensions 95. Calculate AD and the percentage share of consumption. [3]
Step 1: exclude what does not belongPensions are transfer payments, so they are not part of G.Step 2: use AD = C + I + G + (X − M)AD = 620 + 180 + 240 + (190 − 230)AD = 1040 + (−40)AD = $1,000 billionStep 3: consumption as a share(620 ÷ 1000) × 100Consumption is 62% of ADNet exports are negative here, which is completely normal for an economy that imports more than it sells abroad.
WORKED EXAMPLE
State whether each of the following causes a movement along the AD curve or a shift, and give the direction: (a) the average price level falls, (b) the central bank cuts interest rates, (c) a major trading partner enters recession. [3]
(a) the average price level fallsThis is the variable on the vertical axis, so the curve does not move.Movement along AD: an expansion of real GDP demanded(b) interest rates are cutborrowing is cheaper, so C and I both riseAD shifts right(c) a trading partner enters recessiontheir incomes fall, so they buy fewer of our exports, so X fallsAD shifts leftName the component every time. It is what turns a guess into an explanation.
💡 Exam tip
Label the axes properly: average price level on the vertical, real GDP on the horizontal. Marks are lost here every session.
Use the right vocabulary. Expansion and contraction for movements, shift left and shift right for the whole curve.
Name the component that changed. Always route your explanation through C, I, G or X − M.
Mention relative sizes when it helps. A change to consumption matters far more than an equal change to net exports.
Do not use micro reasoning for the downward slope. Substitution to another good does not work when the good is the whole economy.
Draw the diagram big enough to label. A cramped sketch you cannot annotate is worth very little.
⚠️ Common mix-up
Shifting the curve when the price level changes. That is always a movement along.
Putting “price” on the vertical axis. It is the average price level for the whole economy.
Treating investment as buying financial assets. Investment is firms buying capital goods.
Including transfer payments in G. Nothing was produced, so nothing is counted.
Forgetting that net exports can be negative. A minus sign here is not a mistake.
Assuming AD and GDP are the same thing. AD is planned spending at each price level. GDP is what actually got produced.
Up next: What Shifts Aggregate Demand, which goes through every determinant of the four components and how each one moves the curve.
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