Recall that demand is the willingness and ability of consumers to purchase a good or service at various prices in a specific period of time. Aggregate demand (AD) is a similar concept, but has some important distinctions. AD is the demand for all final domestic production in a country. Instead of just households, AD comes from all sectors of the economy. Furthermore, AD relates the price level to the amount of real GDP instead of price to quantity.

The relationship between the price-level and the amount of real GDP is inverse. The higher the price level, the less real GDP is demanded, and the lower the price level, the more real GDP is demanded. This is true because as the price level rises, money and other financial assets lose purchasing power. Fewer people demand our exports, and corresponding higher interest rates discourage investment and consumption. As the price level decreases, purchasing power increases, exports become more affordable to foreigners, and the corresponding lower interest rates encourage investment and consumption.

Changes in AD occur when consumption, private investment, government spending, or net exports change independent of changes in the price level. For example, if the general mood of the country improves and consumers and businesses are feeling more confident, they will consume and invest more, regardless of the price level. This increase in consumption and investment increases AD. Likewise, increases in government spending or net exports also tend to increase AD. Reductions in any of the spending components of GDP will tend to suppress AD. If government raises the average tax rates on income, households' disposable income is reduced, and they consume less, which reduces AD.