Aggregate Supply and Aggregate Demand

Aggregate Supply and Aggregate Demand

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Aggregate Supply and Aggregate Demand

Introduction

Aggregate demand is the total sum of goods and services in an economy within a given time and price. Aggregate supply is the total sum of goods and services supplied during a specific time in an economy.  When aggregate supply equals aggregate demand, then the result is termed as equilibrium in macroeconomic models. Does this situation always occur?

Aggregate Supply/Aggregate Demand Model

The Aggregate Supply/ Aggregate Demand (AD/AS) model is useful for evaluating the conditions and factors that affect the level of Real Domestic Product (GDP) and inflation. The factors affecting aggregate demand include level of income, wealth, population, interest rates, credit availability, government demand, taxation, investments, etc. Those that affect aggregate supply are costs, labour wages, recourses available, productivity, and expectations like profits, inflationary and interest rates. According to Keynesian economics, not all GDP investment sums as part of aggregate and demand thus there would be reduced national output and income when there is unplanned investment.

Production process sometimes produces excess goods that result in reduction in prices or demand. So when aggregate expenditures are not equal to aggregate production, this results in changes in prices. This situation is where buyers and the sellers are out of balance. The household, government are unable to purchase all the real production that the producers have and are unable to sell.  Disequilibrium simply means an imbalance between total demand and total supply in production.  Equilibrium aggregate market is the state where the real aggregate expenditures are equal to real production. This implies that real expenditures and or production do not change, i.e., the opposing forces of aggregate demand and aggregate supply is in balance.

The aggregate supply curve does not usually change independently as the aggregate demand curve does. The aggregate supply curve equation does not contain factors that are directly related the price level or level of output. The aggregate supply curve contains only factors derived from the AD/AS model.

Shifts in the Aggregate Demand Curves

If the demand curve moves towards the left, the total sum of quantity of goods and services needed at any given price levels falls, this is termed as the economy contracting. Consumption and investments lead to a shift to the left. The changes include increases in taxes, making consumption to decrease, or an increase in the savings rate would also have the same effect. Economic expansionary policy changes the aggregate demand curve to the right while economic diminishing policy shifts the aggregate demand curve to the left. Short period total supply movements to the left only affect change in total demand and a change of the price level. The convergent point where the immediate grand supply curve and the total demand curve meet is always the new equilibrium. Thus, expansionist  policies causes output and the price level to increase in the short run, but only the price level to move upwards  in the long run. The opposite case is found when the aggregate demand curve shifts to the left. When demand changes, the economy always moves from the long-term equilibrium to the short-term equilibrium, and then back to a new long-term equilibrium position (Palley, 1997).

Changes in the supply curve are few, unless in response to the aggregate demand curve. Sometimes a supply shock can occur, e.g., Increases in oil prices, drought, union strikes, etc where the short run supply curve shifts without prompting from the demand side, thus changing the price level of a given amount of output. A positive supply shock causes the price for a given amount of output to reduce. This is represented by the movement of the absolute movement of the supply curve to the right.

Disequilibria between Aggregate Supply and Aggregate Demand

There are varied factors that cause the condition of disequilibria. These include consumer nominal wealth increases, technology and education increase, planned investment spending, business profit expectations decrease, employee wages increase, etc. Others could be  government purchases increase, temporary increases in oil prices, labour endowment increases, permanent increase in business regulations, national income abroad increases, net export spending decreases, prices of raw materials temporarily increases, as well as personal taxes increase (Palley, 1997).

There are many different kinds of buyers, that both rich and poor who want consumer goods and the private companies who want investment goods. Therefore, private households spend their wages on consumer goods. Households may not buy all of the commodities that have been produced, but the workers cannot afford. There is a possibility that investment demand will be high enough to compensate for the insufficient level of workers plus capitalist demands for consumer goods.  There are so many times of economic upswing where capitalists expect aggregate demand to rise and ensure they enjoy the demand. They may opt to increase production by expanding investments. If they realize that the demand is not high enough for consumer goods, they will cut back their investment plans. Thus will to lower prices will not bring aggregate demand level up to the level of aggregate supply. Capitalists will still need to have total profits and turnover to remain constant, which will make disequilibria persist. In a competitive economy, some companies will lower their prices and other will not. Those who lower the prices will enjo.............