A:

According to Keynesian macroeconomic theory, gross domestic product (GDP) is a way to measure a nation's production. Aggregate demand takes GDP and shows how it relates to price levels. Quantitatively, aggregate demand and GDP are exactly the same.

A Keynesian economist might point out that GDP only equals aggregate demand in long-run equilibrium. This is because short-run aggregate demand always measures total output for a given price level (not necessarily equilibrium). In most macroeconomic models, however, the price level is assumed to be equal to "one" for simplicity.

It must always be the case that an increase in aggregate demand will increase GDP since the two figures are one and the same.

Calculating Aggregate Demand and GDP

There are actually three methods for estimating GDP:

  • Total value of all goods and services sold to final users
  • Sum of income payments and other production costs
  • The sum of all value added at each production stage

Conceptually, all of these measurements are tracking the exact same thing. Some differences can arise based on data sources, timing and mathematical techniques used.

In general macroeconomic terms, both GDP and aggregate demand share the same equation:

GDP and aggregate demand = total consumption spending + gross private investments + total government expenditures + net of exports – imports

You may also see the equation written this way:

GDP or AD = C + I + G + NX

Potential Issues

GDP and aggregate demand are often interpreted to mean that economic growth is driven by the consumption of wealth and not its production. In other words, it disguises the structure and relative efficiency of production underneath total expenditures.

Additionally, GDP does not take into consideration the nature of what, where and how goods are created. For example, it does not distinguish producing $100,000 worth of toenail clippers versus $100,000 worth of computers. In this way, it's a somewhat unreliable gauge of real wealth or the standard of living.

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