Aggregate demand (AD) is really important for understanding how the whole economy works. It's what happens when the total demand for goods and services matches the total supply at a certain price. We can show this relationship with a simple equation:

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

Here’s what those letters stand for:

• C = Consumption (what people buy)
• I = Investment (money spent on things like buildings or equipment)
• G = Government Spending (money spent by the government)
• X = Exports (goods sold to other countries)
• M = Imports (goods bought from other countries)

Key Parts of Aggregate Demand

1. Consumption (C):

   • This is about 60% of total aggregate demand in developed countries.
   • If people feel good about the economy, they’ll spend more money.

2. Investment (I):

   • This usually makes up around 15-20% of aggregate demand.
   • When businesses feel confident about the future, they invest more money.

3. Government Spending (G):

   • This is about 20-25% of aggregate demand.
   • When the economy is struggling, the government can spend more money to help it bounce back.

4. Net Exports (X - M):

   • This is a smaller part, around 5-10% of aggregate demand.
   • The balance between what we sell to other countries and what we buy from them can change based on how strong our currency is and what other countries want.

How It Affects Equilibrium

• Shifts in Aggregate Demand:
  • If aggregate demand increases by 5%, it can lead to higher production and prices. This might cause inflation if the economy is already at full employment.
• Policy Effects:
  • During tough economic times, the government might increase spending by 2% of GDP. This can help the economy grow again. For example, during the 2008 financial crisis, the UK government made changes that raised aggregate demand and helped the economy recover.

In short, aggregate demand is a key player in how the economy stays balanced. Different things that affect its parts can change how much things cost and how much is produced. That’s why it’s important for the government and other decision-makers to be ready to act to keep everything stable.