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I have been tasked with teaching some students macroeconomics, and will shortly need to introduce them to the concept of 'aggregate demand'. Usually, this is defined by the following sort of equation:

$AD$ = $C + I + G + X - M$

where the symbols have the usual interpretations.

My question is whether aggregate demand is supposed to refer to the quantity that is demanded or rather the value of total demand.

Both options would seem to present difficulties:

On the one hand, if we say that aggregate demand is a quantity, one needs to ask 'of what?' Naturally, if there were just one good in the economy, answering this would be easy. But in reality, there are many different goods. Are we supposed to just add up the quantities demanded of all these different goods (e.g. if people demand 5 laptops, 3 apples and nothing else, aggregate demand is 8)?

On the other hand, we might say that aggregate demand is the value of total demand, i.e. $p_{1}q_{1} + ... + p_{n}q_{n}$ where $p_{i}$ and $q_{i}$ are the quantity demanded and price of good $i$. That seems a bit more meaningful, but then it is far from intuitive that aggregate demand falls when the 'overall price level' (whatever that is) rises. For one might have thought that if prices rise, the value of total demand would (sometimes) rise, just as a firm's total revenue can increase when the price increases (if demand is inelastic).

My apologies if the answer is obvious; I am simply not very familiar with macroeconomics.

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We measure these in values.

Also, this is a macroeconomic identity, it holds always by design.

You need an economic model that will make specific behavioral and other assumptions, in order to discuss movements when the price level change.

For example, you write

it is far from intuitive that aggregate demand falls when the 'overall price level' (whatever that is) rises

Even in introductory economics courses beware of "intuitive" thinking.

And indeed, where is the model and its assumptions based on which one would argue that as price level rises aggregate demand falls? It is certainly not embedded in the macroeconomic identity.

Find the model that predicts so, understand its assumptions, and then discuss whether these assumptions are "intuitive".

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  • $\begingroup$ Thanks for your response. If aggregate demand is a value, then presumably it depends on the price level. But in introductory macro, is aggregate demand not used to determine the price level? $\endgroup$ – afreelunch Jul 17 '18 at 13:13
  • $\begingroup$ Aggregate demand as a response curve, i.e. a function, in its crossing with another response function, aggregate supply. Not the value of aggregate demand that satisfies the macroeconomic identity. This is just a value, the point where the "Aggregate demand function" crosses with Aggregate Supply function. $\endgroup$ – Alecos Papadopoulos Jul 17 '18 at 13:34
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It is rare, though not exactly wrong, to say that $C+I+G+X-M$ is indeed a quantity. Of what? Of homogenous output $Y$, priced at the price level $P=1$.

It honestly seems very confusing to me, but I can't think of it as being wrong.

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