What this lesson teaches
I can name the parts of aggregate demand: consumption, investment, government spending and net exports.
Syllabus 9570, 3.1.2(a). Aggregate Demand and Aggregate Supply: Aggregate Demand (AD) and its components: consumption (C), investment (I), government spending (G) and net exports (X - M)
Make a guess
Singapore's GDP in dollars rises by 5% in a year, but prices also rise by 5%. Did real output rise?
- No. The rise came from prices, so real output barely changed.
- No. Real output fell, because higher prices cut what people buy.
- Yes, by about 10%, because both GDP and prices went up.
Show the answer
No. The rise came from prices, so real output barely changed.
Real output removes price changes. If the dollar value and prices both rose 5%, the quantity of goods and services stayed about the same.
AD/AS shows how total spending and total production set real output and the general price level.
Macroeconomics looks at the whole economy. The AD/AS diagram is its main tool.
The vertical axis shows the general price level: the average level of prices across the economy. The horizontal axis shows real national output: the total quantity of goods and services produced, with price changes removed.
Aggregate demand (AD) is total planned spending on the country's output. Aggregate supply (AS) is the total output firms are willing and able to produce at each price level.
Where they meet, E0, gives the equilibrium level of real output (Y0) and the general price level (P0).
- Vertical axis
- General price level.
- Horizontal axis
- Real national output.
Worked example: Reading a change on the diagram
Suppose an economy moves from an output index of 100 and a price index of 100 to 120 and 110.
- Real output rose by 20%: the economy produced more goods and services.
- The general price level rose by 10%.
- Both rising together suggests AD increased.
- One move like this does not show inflation will keep going; we would need more periods of data.
Watch out for this
National output on the diagram is measured in dollars at current prices.
It is real output, with the effect of price changes removed, so it measures the quantity of goods and services.
Check your understanding
What does the vertical axis of an AD/AS diagram show?
- The general price level.
- The price of one typical good, such as rice.
- The interest rate.
Show the answer
The general price level.
Right. It is the average level of prices across the whole economy.