Aggregate demand and aggregate supply: concepts, structure and factors that determine them

The section “Microeconomics” analyzes the demand, supply and price of individual goods in single markets. In the section “Macroeconomics” these categories are considered at the level of the national economy. Therefore, here the concepts of “demand”, “supply” and “price” are applied to all products and services created in the country, i.e. to the national product.

To determine aggregate demand, aggregate supply, and aggregate price within a national economy, it is necessary to combine thousands of individual prices, commodities, and markets. Combining them into one aggregate price, one aggregate commodity, and one aggregate market is called aggregation. Thus, the object of macroeconomic analysis, the theory of supply and demand is the national market, the aggregate price (price level) and the real national product.

The national market can be considered as a set of socio-economic relations in the sphere of exchange, through which the sale of goods and services, the circulation of capital, the purchase and sale of labor on a national scale are carried out.

The main economic subjects of the national market are the state, households and firms (enterprises). The state provides the population and firms with public goods, carries out purchases of goods and services, and also pays salaries to civil servants. Firms produce products and services, raise money for it and demand labor. Households offer labor and monetary resources, receive remuneration for them and demand the products of firms. Thus, the national market functions in the form of:

market of goods and paid services; money and securities market; labor market.

In each of these markets, aggregate demand and aggregate supply interact with each other, and an equilibrium is established between them.

Aggregate demand is the demand for the total volume of goods and services that can be presented at a given price level. It has two forms: natural-material and valuable. The natural-material form of aggregate demand reflects the social need of the population, firms and the state for goods and services. Its structure can be represented by: first, certain types of products and services of non-productive consumption, satisfying personal and other non-production needs; secondly, the totality of all means of production and production services (research and development aimed at improving technology; information serving production; communications, etc.).

Aggregate demand in value terms is the sum of all expenditures on final goods and services produced in an economy. It reflects the relationship between the volume of aggregate output, which is demanded by economic agents: the population, enterprises and the state, and the general price level in the economy. In the structure of aggregate demand, we can distinguish:

consumption C (C – from the English consumption – consumption) – the demand for consumer goods and services; investmentS I (I – from the English investment – investments) – demand for investment goods; public procurement G (G – from the English government – government) – the demand for goods and services from the state; Net export Xn is the difference between the demand of foreigners for domestic goods (exports) and domestic demand for foreign goods (imports).

Aggregate demand is equal to the total amount of demand for final products:

C + I + G + Xn.

Some components of aggregate demand are relatively stable, changing slowly, such as consumer spending. Others are more dynamic, such as investment spending, and changes cause fluctuations in economic activity.

The aggregate demand curve (AD) shows the amount of goods and services that consumers are willing to purchase at each possible price level. It gives such combinations of the volume of output and the general price level in the economy, at which the commodity and money markets are in equilibrium. Movement along the AD curve reflects the change in aggregate demand depending on the dynamics of the general price level. The simplest expression of this dependence can be obtained from the equation of the quantitative theory of money:


from here or or   ,

where  P is the price level in the economy, in this case the price index;

Q is the real volume of output for which demand is presented;

M is the amount of money in circulation;

V is the velocity of money circulation.

Consequently, AD is directly dependent on the money supply and the velocity of money circulation and in the opposite – on the price level.

Aggregate demand, being inversely dependent on the price, decreases under the influence of a number of factors. These include:

The “interest rate level effect”, i.e. the price of using the loan. The fact is that the rise in the price level forces both consumers and producers to borrow money. This circumstance increases the interest rate. Therefore, buyers postpone their purchases, and entrepreneurs reduce investments. As a result, aggregate demand decreases. This phenomenon is called the “interest rate effect.” “The effect of cash balances”, or “wealth effect”. Rising prices reduce the real purchasing power of accumulated fixed-value financial assets (bonds, term accounts), which makes their owners poorer and encourages them to reduce costs. “The effect of imported goods”. Rising prices within the country with stable import prices shift part of the demand from domestic goods to imported ones and reduce exports, which reduces aggregate demand in the economy.

The non-price factors affecting aggregate demand include everything that affects consumer spending, investment expenditures of firms, government spending, net exports: consumer welfare, their expectations, taxes, interest rates, subsidies and preferential loans to investors, etc. From the equation of the quantitative theory of money, it can be concluded that aggregate demand is affected by the size of the money supply and the speed of money circulation between sectors of the economy. Therefore, AD is a function of M and V; AD = f (M, V). The influence of the above non-price factors on aggregate demand can ultimately be reduced to changes in the money supply and the velocity of money circulation. The change in non-price factors is reflected by a shift in the AD curve. For example, an increase in the supply of money (or the velocity of its circulation) and a corresponding increase in effective demand in the economy will be reflected in the graph by shifting the AD curve to the right (Figure 8.1), which will occupy the position of A1D1. A decrease in demand, for example, for oil on the world market and a corresponding reduction in exports will lead to a reduction in aggregate demand. This will be reflected graphically by shifting AD to the left. The aggregate demand curve will take the position of A2D2.

Aggregate supply is the total amount of final goods and services produced in an economy (in value terms). This concept is often used as a synonym for gross national or domestic product.

The aggregate supply curve, AS (from the English aggregate supply), shows how much real volume of national production (aggregate output) can be offered to the market by entrepreneurs at different values of the general price level in the economy. AS can be equated to the value of gross national product (GNP) or to the value of gross domestic product (GDP).


The ability of the economy to produce a particular volume of goods and services is affected by the quantity and quality of the factors of production (land, labor, capital, entrepreneurial abilities). Then

AS = rent + salary + interest + profit.

An increase in the quantity or quality of factors of production leads to an increase in production capacity, and hence to the growth of AS. The aggregate supply curve conditionally consists of three parts:

horizontal or Keynesian, when production grows at an unchanged price level and with incomplete use of production capacities and resources; upward, when the volume of the national product increases and prices rise; vertical or classical, when the economy reaches the highest point of its production capabilities. Therefore, the real volume of production of the national product does not increase, and the growth of its nominal volume is associated only with an increase in the price level.

Aggregate supply depends on the price level. Higher prices stimulate the production of goods and their supply. Lower prices, on the contrary, reduce the production and supply of goods.

Aggregate supply is affected not only by price, but also by non-price factors. If price factors show movement along the aggregate supply curve AS, then non-price factors shift the curve to the right (A1S1) when costs decrease and to the left (A2S2) when they increase. Non-price factors include those that can change costs:

prices for resources (land, labor, capital). Their increase increase increases production costs, therefore reduces the total supply and the AS curve shifts to the left. Lower prices cause a backlash; the growth of labor productivity increases the volume of production and thereby the total supply and the AS curve will shift to the right; legal regulation (taxes, subsidies): if taxes rise, costs will increase, aggregate supply will decrease, the curve will shift to the left, and vice versa.

It should be noted that changes in the value of aggregate supply under the influence of the same factor, say, aggregate demand, may be different. This depends on whether we take into account changes in aggregate demand over a short period of time or whether we are interested in the long-term consequences of this factor.

The difference between the short-term (usually up to 2-3 years) and long-term period in macroeconomics is associated mainly with the behavior of nominal and real variables. In the short term, nominal values (prices, nominal wages, nominal interest rate) change slowly under the influence of market fluctuations, usually talking about their relative “rigidity”. Real values (output, employment rate, real rate, interest) are more mobile, “flexible”. In the long term, on the contrary, nominal values eventually change quite strongly, they are considered “flexible”, and real ones change extremely slowly, so that for the convenience of analysis they are often considered as constant.

Therefore, if we consider the behavior of the economy in the long term, the AS curve will be vertical at the level of output at full employment factors, and when the functioning of the economy is studied for relatively short periods of time, the AS curve is horizontal (at rigid prices and nominal wages) or has a positive slope (with rigid nominal wages  relative to moving prices).