Aggregate Demand

A High School Economics Guide

Supplementary resources for high school students

Definitions and Basics

The Aggregate Demand Curve, from Marginal Revolution University

Keynesian Economics, from the Concise Encyclopedia of Economics

Keynesian economics is a theory of total spending in the economy (called aggregate demand) and of its effects on output and inflation….

Fiscal Policy, from the Concise Encyclopedia of Economics

The most immediate effect of fiscal policy is to change the aggregate demand for goods and services. A fiscal expansion, for example, raises aggregate demand through one of two channels. First, if the government increases its purchases but keeps taxes constant, it increases demand directly. Second, if the government cuts taxes or increases transfer payments, households’ disposable income rises, and they will spend more on consumption. This rise in consumption will in turn raise aggregate demand.

Fiscal policy also changes the composition of aggregate demand. When the government runs a deficit, it meets some of its expenses by issuing bonds. In doing so, it competes with private borrowers for money loaned by savers. Holding other things constant, a fiscal expansion will raise interest rates and “crowd out” some private investment, thus reducing the fraction of output composed of private investment.

In the News and Examples

Using Infographics to Visualize Macroeconomic Data: The AD-AS Model, from the Federal Reserve Bank of Atlanta

In this lesson, students will review content associated with the aggregate demand-aggregate supply (AD-AS) model through participation in a card-matching game. They will move around the room looking for the persons who have the economic concepts associated with the descriptions on their cards. After reviewing, students will work in groups or independently to create an infographic for key macroeconomic concepts and data associated with the model.

Effects of trying to boost the economy via aggregate demand during business cycles: Gross Domestic Product, from the Concise Encyclopedia of Economics

In the short run, in business cycles the Keynesian emphasis on demand is relevant and alluring. But heavy-handed reliance on “demand management” policies can distort market prices, generate major inefficiencies, and destroy production incentives. India since its independence and Peru in the eighties are classic examples of the destruction that demand management can cause. Other less developed countries like South Korea, Mexico, and Argentina have shifted from an emphasis on government spending and demand management to freeing up markets, privatizing assets, and generally enhancing incentives to work and invest. Rapid growth of GDP has resulted….

A Little History: Primary Sources and References

John Maynard Keynes, biography from the Concise Encyclopedia of Economics

Keynes’s General Theory revolutionized the way economists think about economics. It was path breaking in several ways. The two most important are, first, that it introduced the notion of aggregate demand as the sum of consumption, investment, and government spending….

Pedro Schwartz, Keynes as Lucifer, at Econlib, September 2015

The leading ideas of this book are: the first, that he presents aggregate demand as the engine of growth instead of productive investment as the classical economists would. The second is that he introduces expectations as a fundamental modifying element in the functioning of the economy. The third is that he suggests that money has very little to do with inflation.

John R. Hicks, biography from the Concise Encyclopedia of Economics

His second major contribution was his invention of what is called the IS-LM model. The IS-LM model is a graphical depiction of the argument Keynes gave in the General Theory about how an economy could be in equilibrium with less than full employment. Hicks published it in a journal article the year after Keynes’s book was published. It is reasonably certain that most economists became familiar with Keynes’s argument by seeing Hicks’s graph….

Advanced Resources

Arnold Kling on Patterns if Sustainable Specialization and Trade, at EconTalk, February 2011.

Arnold Kling of EconLog talks with EconTalk host Russ Roberts about a new paradigm for thinking about macroeconomics and the labor market. Kling calls it PSST–patterns of sustainable specialization and trade. Kling rejects the Keynesian approach that emphasizes shortfalls in aggregate demand arguing that the aggregate demand approach masks the underlying complexity of the recalculations that periodically take place in a dynamic economy. Instead, Kling invokes the mutual exploration between entrepreneurs and workers for profitable opportunities that pay well using the workers’ skills. This exploration takes time, involves trial and error, and can have false starts because businesses sometimes fail or employees are difficult to find or match with employment opportunities. Kling applies these ideas to the current crisis to explain why labor market recovery is so sluggish and what might policies might improve matters.