Aggregate Demand Supply Model of an Economy - Essay Example

Name Course Instructor Date of submission Aggregate Demand Supply Model of an Economy The aggregate demand and supply model of the economy is acronymic the AS/AD model.This model is discussed as an aggregation of the microeconomic models within a specific economy. In addition, the model represents the quantity output of a specified entire economy which could be referred to as national production (Dutt 321). The model tries to establish a relationship between the aggregate supply of an economy and the Aggregate demand of the same economy. Ideally, the model is easily presented in the form of a diagram where points of equilibrium get determined by the cross point between the aggregate demand and aggregate supply curves. Ideally, there is a minute difference between the simple demand supply and demand models. P inflationary rate Aggregate demand Aggregate supply Inflationary region E Non-Inflationary Region Y (Real GDP) Ideally, the model incorporates the Y (real gross domestic output) variable compare to the prices of these outputs. The diagram above shows how the model determines situations that undergo inflationary impacts and those that are free from inflation. Particularly, the aggregate demand of the model responds negatively to the change in price and output. Alternatively, the aggregate supply of the entire model responds affirmatively to changes in price and real gross domestic output (Taylor 92). The negative slope signified by the aggregate demand curve implies that if given any amount of nominal income, purchasers always feel capable of buying more of the real goods at lowered prices. Alternatively, the purchasers are not capable of buying these products as the prices rise at the same income level. Therefore, the aggregate demand is the cumulative of all the levels of spending in the national income accounts (Beetsma 17). These national income variables include the consumption, investment, government purchases and net exports. Alternatively, the aggregate supply (AS), which shows an affirmative response to the changes in economic variables, accommodates and explains most of the economic issues that result into inflation or are affected by inflation. According to the model, the interaction of the aggregate demand and the aggregate supply curves yields to the equilibrium level of real national output (GDP) (Fatás 1425). In addition, this equilibrium also determines the level of inflation affecting the economy of the subject state. Methods Used to Move the Economy to Move Closer to Full Employment First, when the equilibrium level of output is below that of the full employment, this signifies that the economic GDP (Gross Domestic Product) level is very low (Fatás 1425). Ideally, at this time, the level of aggregate supply of labour variable is high as compared to the level of demand for the labour. Ideally, according to classical economists, self-adjustment mechanisms are essential in restoring the employment stalemate hence enabling the economy to achieve full employment. Ideally, should the economy deviate from full employment where structural unemployment is an exception, some impartial but unrealistic methods can be used to arrive at a full employment. The weakness of this proposal is that full employment is not realistic for any economy that intends to avoid the wrath of economic inflation. However, the self-adjustment methods are expected to take a longer time than they are expected to. The argument by accredited economist John Maynard Keynes indicates that there is a feasibility that the economy fails to achieve the resolution fast enough through self-adjustments. This leads to prolonged periods of underemployment. One of the leading factors that can assist in identifying the appropriate strategies of raising the equilibrium towards full employment is the GDP. For any full employment to get achieved, the nation ought to improve the domestic income rate. Otherwise, it is hard to adjust elements such as an aggregate wage for the entire economy in the absence of new injections from within or outside the economy (Fatás 1431). Therefore, the level of production ought to be elevated for the economy to sustain more employment units. For instance, producers increase the level of production and also facilitate more employment. The high the employment rate increases the aggregate level of demand for the products. Use of Fiscal and Monetary Policies to Manipulate Aggregate Supply and Demand P inflationary rate inflationary region Aggregate demand Aggregate supply Non-Inflationary Region Y (Real GDP) The diagram above is essential in determining the point that the economy is expected to achieve at full employment. Ideally, achieving full employment requires that the demand for the labour supply shifts affirmatively. That is the original aggregate demand curve moves towards the right. This will increase the level of supply along the supply chain. In addition, the level of equilibrium real domestic output is expected to rise. Using the fiscal and monetary policies, this is achievable. However, it may not be economically susceptible in the long-run. First, the government may use a direct method of increasing its spending rate. For instance, the government may engage in the increased spending on projects such as construction and reforestation. The project will generate more jobs and the level of income for the persons who are employed (Beetsma 19). Accordingly, the aggregate demand for the products will rise. The government is recommended to use the fiscal policy to make up the shortfall for the private aggregate demand hence creating more jobs. The fiscal policy is one economic policy that dwells on adjusting fiscal aspects such as government expenditure, interest rates and taxes. P inflationary rate Aggregate demand Aggregate supply E1 E2 Inflationary region Non-Inflationary Region Y Ideally, the fiscal policy used by the government-influenced the increase in the money circulation since the interest rates get reduced, and the level of income for the aggregate economy is raised. Resultantly, the diagram above shows the manner in which the aggregate demand and supply behaves after the fiscal policies remain enacted in favour of the unemployed persons. Increased expenditure increases the level of demand and supply to the new equilibrium. An increased level of Y means that the GDP of the economy is also elevated (Benigno 302). Previously, it is discussed that the level of employment is greatly influenced by the level of GDP of the economy. An increase in the level of GDP triggers an increase in the level of employment. According to economic experts, full employment is not easily achievable, not unless the economy facilitators are ready to tumble the economy’s status by encouraging virtual projects to take the course continuously in the country (Woodford 460). Alternatively, the monetary policy is also used to manipulate the money supply in the economy. Ideally, an increase in the money supply elevated the aggregate demand in the economy. That is; more people get access to the money due to increased channels of acquiring income by the people who were previously unemployed (Benigno 297). A merge of the fiscal and monetary tools to adjust the economy may result into increased levels of employment. At times, full employment may not get achieved. However, the efforts to make employment easy to acquire for the citizens of that particular nation may be fruitful. That is; the level of employment may increase along the aggregate supply curve. The disadvantage of this method of increasing the level of employment to full employment is inflation. Ideally, inflation elevates every time unnecessary money supply is facilitated into the economy. For instance, the shifts and increase in the aggregate demand and supply lead to an increase in the price levels in the economic set up. Variables Affected in Order to Bring About Changes in The Aggregate Supply and Aggregate Demand The variables affected are the price, domestic levels of output (Y) and hence influencing the level of inflation. Ideally, when the fiscal and monetary policies are introduced to help in achieving full employment, the monetary policies affect the price stability in the economy (Beetsma 19). Ideally, increase in money circulation within an economy results into irrelevant rise in price levels. For instance, the increase in money circulation increases the demand for the products. Resultantly, the producers tend to raise the level of process taking advantage of the availability of finance (Woodford 450). In addition, the domestic currency loses value in relation to the international currencies within the foreign exchange forum. Variables Affected by the Government Ideally, the price variable is largely affected by the government’s intervention to facilitate fiscal policies such us reduction of taxes and to increase of subsidies through government expenditure. Ideally, the government’s effort to increase the amount of money that the economy can have easy reach facilitates loss of value of the domestic currency. Therefore, the price stability is affected since the increase in Y facilitates increase in price for the same set of products. However, the expected level of employment is achieved. Works Cited "Aggregate Supply / Aggregate Demand Model." Harper College, Palatine, Il. N.p., n.d. Web. 1 Oct. 2014. "Economic Policy." Reference For Business - Encyclopedia of Small Business, Business Biographies, Business Plans, and Encyclopedia of American Industries. N.p., n.d. Web. 1 Oct. 2014 Beetsma, Roel MWJ, Xavier Debrun, and Franc Klaassen. Is fiscal policy coordination in EMU desirable?. International Monetary Fund, 2001. Benigno, Pierpaolo. "Optimal monetary policy in a currency area." Journal of International Economics 63.2 (2004): 293-320 Dutt, Amitava Krishna. 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