Aggregate demand (AD) or Domestic Final Demand (DFD) is the total demand for final goods and services in an economy at a given time. It specifies the amount of goods and services that will be purchased at all possible price levels.
Components of aggregate demand are :
AD=C+I+G+(X−M)
Where
C‌=‌ Consumption ‌
I‌=‌ Investment ‌
G‌=‌ Government Spending ‌
X−M‌=‌ Net Exports ‌
(i) Consumption : This is made by households, and sometimes consumption accounts for the larger portion of aggregate demand. An increase in consumption shifts the AD curve to the right.
(ii) Investment : Investment, second of the four components of aggregate demand, refers to the spending by firms not households. However, investment is also the most volatile component of AD. An increase in investment shifts AD to the right in the short run and helps to improve the quality and quantity of factors of production in the long run.
(iii)Government : Government spending forms a large total of aggregate demand, and an increase in government spending shifts aggregate demand to the right. This spending is categorized into transfer payments and capital spending. Transfer payments include pensions and unemployment benefits and capital spending is on things like roads, schools and hospitals. Government spends to increase the consumption of health services, education and to re-distribute income. They may also spend to increase aggregate demand.
(iv) Net Exports : Imports are foreign goods bought by consumers domestically, and exports are domestic goods bought abroad. Net exports is the difference between exports and imports, and this component can be net imports too, if imports are greater than exports. An increase in net exports shifts aggregate demand to the right. The exchange rate and trade policy affects net exports.