Aggregate supply and aggregate demand is the total supply and total demand of all goods and services in an economy. Most nations have economies made up of individual industries and sectors, with each one adding to the overall economy. Consumer demand for goods and services affect how companies will meet that demand with products. This creates a symbiotic relationship that allows companies to determine which product will be most profitable to produce. The study of supply and demand is known as macroeconomics.
Macroeconomics is a top-down look at an economy. Rather than focusing on economic transactions at the individual level, it attempts to discover the shifts or changes in an economy through government policies and natural market forces. Aggregate supply and demand play an important role in the macroeconomic study. Changes in unemployment, national income levels, growth rates, inflation, price levels, and gross domestic product all affect both sides of this economic equation.
These two factors are typically represented by curves on a graphical chart. The supply curve starts at the bottom left and slopes upward toward the top right of the graph. While not a simple sum of all individual supply curves in economics, low levels of supply will represent a flat supply curve. As more companies increase produce products, the supply curve becomes more vertical as it slopes up the chart.
The aggregate demand curve starts at the top left of the chart and slopes downward toward the bottom right of the graph. This curve slope down because of consumption and the real wealth effect. An increase in interest rates by the central bank will result in lower demand as purchasing power decreases. The real wealth effect forces demand down as the price for goods and services increase, creating lower demand.
Aggregate supply and aggregate demand affect the price of products. Each curve intersects at some point on the graph; this represents the equilibrium point for goods and services. At this price point, consumers will typically purchase the most products. Shifts occur when monetary policy increases or decreases the money supply. A loose money policy tends to increase supply and demand as more money exists for business investment and consumption, while a tight money supply has the opposite effect. Additionally, more government regulations or taxes will tend to retard the economy as these factors increase the barriers to entry or penalize individuals and firms for economic activity.