International Finance Theory and Policy
by Steven M. Suranovic

Finance 50-1

Aggregate Demand for Goods and Services

The Keynesian model of aggregate demand for goods and services is developed by identifying key determinants of demand for the national output. When we talk about "aggregate" demand, it means demand by households, businesses and the government for anything and everything produced within the economy. The starting point is the national income identity, which states that,

GNP = C + I + G + EX - IM

i.e., the gross national product is the sum of consumption expenditures, investment expenditures, government spending, and exports minus imports of goods and services.

We rewrite this relationship as,

AD = CD + ID + GD + EXD - IMD

where the left-hand-side, AD, refers to aggregate demand for the GNP and the right-hand-side variables are read as consumption demand, investment demand, etc. Determinants of the right-hand-side variables will be considered in turn.

It is important to remember that demand is merely what households, businesses and the government "would like" to purchase given the conditions that exist in the economy. Sometimes demand will be realized, as when the economy is in equilibrium, but sometimes demand will not be satisfied. On the other hand the variable Y, for real GNP, represents the "aggregate supply" of G&S. This will correspond to the actual GNP whether in equilibrium or not.

Next we'll present the determinants of each demand term: Consumption, Investment, Government, Export and Import demand.

International Finance Theory and Policy - Chapter 50-1: Last Updated on 1/20/05