9.3: Aggregate Demand

The economy falls into recession when the actual level of output (QE) falls below full-employment level of output (QF). This fall in output is caused by either a leftward shift in aggregate demand or aggregate supply. See figure 6. 

Figure 6

The generally accepted cause of the Great Depression was a collapse in aggregate demand. The stock market crash of 1929 was a symbolic start but was not the main cause of the fall in demand. Economists and historians are still debating exactly what caused the fall in aggregate demand. But most agree that poor government decisions turned what would have been a modest recession into the most devastating downturn of the century. This is why it is important to understand how an economy can fall into a recession and what can be done to bring about a recovery or, at least, not make the recession worse. 

Components of Aggregate Demand 

Recall in the GDP chapter the way we broke down GDP into four spending components: 

• Consumption 

• Investment 

• Government 

• Net Exports 

This process (called the Expenditure Approach) accounts for output within a nation’s borders by totaling the spending on that output. We can use the same approach to break down the different sources of aggregate demand.  

AD = Consumption + Investment + Government + Net Exports 

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