Aggregate Demand

Aggregate demand combines the spending of four groups: households on consumption, businesses on investment, government on goods and services, and foreigners on a country's exports, minus the country's spending on imports.

Changes in aggregate demand drive short-term fluctuations in economic activity. When aggregate demand rises, businesses sell more, increase production and hire more workers. When it falls, output and employment decline.

Many factors influence aggregate demand, including interest rates, consumer and business confidence, household wealth, government spending and taxes, exchange rates and economic conditions abroad. For example, a cut in interest rates makes borrowing cheaper, encouraging households to buy homes and cars and businesses to invest, which increases aggregate demand.

Governments and central banks manage aggregate demand through fiscal and monetary policy. If demand is too weak, unemployment rises; if it is too strong relative to what the economy can produce, inflation tends to rise. The balance between aggregate demand and aggregate supply determines overall output and the price level.