Definition
Aggregate demand (AD) is the total quantity of goods and services that all buyers in an economy — households, firms, governments, and foreign purchasers — want to buy at each price level. It is the economy-wide counterpart to the individual demand curve, but the logic differs: the AD curve slopes downward not because of substitution between goods but because of wealth, interest rate, and exchange rate effects that reduce real spending as the price level rises.
In practice, aggregate demand is nearly synonymous with GDP measured from the expenditure side: AD = C + I + G + (X − M). What distinguishes AD analysis from simple GDP accounting is its focus on what shifts total spending — and how those shifts propagate through the economy via multiplier effects, leading to recessions or inflationary booms.
Why it matters
Demand shocks and the multiplier
The multiplier in detail
Why spending multiplies
When the government spends $100 building a road, it pays workers and contractors who earn $100 in income. They spend perhaps $80 (saving $20), which becomes income for others who spend $64 of it, and so on. The total impact is 1 ÷ (1 − MPC) where MPC (the marginal propensity to consume) is the fraction of additional income spent rather than saved. With MPC = 0.8, the multiplier is 5 — $100 of government spending generates $500 of GDP.
Why multipliers are smaller in practice
The theoretical multiplier assumes a closed economy in a recession with no crowding out. In practice: imports "leak" spending abroad; taxes capture a fraction of each income round; higher government borrowing may push up interest rates and crowd out private investment; and if the economy is near full capacity, extra demand generates inflation rather than output. Empirical estimates of the fiscal multiplier range from 0.5 to 2.0 depending on these factors.