Aggregate Demand (Definition and Why Downward Sloping)
Aggregate Demand is "the total amount of goods and services demanded in the economy at a given overall price level and in a given time period. It is represented by the aggregate-demand curve, which describes the relationship between price levels and the quantity of output that firms are willing to provide".(1)
AD=C+I+G+(X-IM)

external image AD.gif(2)

The aggregate demand curve is downward sloping because of these 3 effects below:when prices goes up, these 3 cause real gdp to go down and when prices fall, real GDP increases
  • real balance effect: prices go down > value of saving goes up > savings goes down > so consumption spending goes up > AE goes up > real GDP goes up
  • interest rate effect: prices go down > interest rates go down > so investment spending goes up > AE goes up > real GDP goes up
  • foreign trade effect: prices go down > export spend goes up, import spending goes down > net exports goes up > AE goes up > real GDP goes up



The aggregate demand curve is downward sloping because as the price level drops the quantity of goods and services people are willing and able to buy increases.


Endnotes:
(1): "Dictionary", www.investopedia.com, accessed April 11, 2012,
http://www.investopedia.com/terms/a/aggregatedemand.asp#axzz1rlnj9U00.

(2): "Demand for Goods and Services in the Economy", www.pcecon.com, accessed April 11, 2012,
http://www.pcecon.com/notes/ADASdefinitions.html.

The aggregate demand is the same formula for aggregate expenditures, therefore, what makes the AE downward sloping will also make the aggregate demand be downward sloping.
  • real balance effect: prices go down > value of saving goes up > savings goes down > so consumption spending goes up > AE goes up > real GDP goes up
  • interest rate effect: prices go down > interest rates go down > so investment spending goes up > AE goes up > real GDP goes up
  • foreign trade effect: prices go down > export spend goes up, import spending goes down > net exports goes up > AE goes up > real GDP goes up


Dr. Stephanie Powers, "Aggregate Demand", Intro to Macroeconomics.(Lecture, Donald School of Business, Red Deer Alberta, Winter 2012)