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Learning Objectives
After reading the chapter, the students would be able to understand the
following:
1. INTRODUCTION
Graph: 1
60,00,000
50,00,000
40,00,000
GDP at 2004-05 Constant Prices
30,00,000
(in Crores)
20,00,000
10,00,000
0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
As can be seen from the graph, the GDP of India when measured at
constant prices has experienced a consistently increasing or a rising
trend. The upward slope of the GDP line is a mark of country’s sound
economic performance. However, when the trend of GDP growth rate
Graph: 2
10
0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
The GDP growth in India has experienced a cyclical pattern over the
nine year period with recording a major downward slump during 2008,
the period of recession that originated in the west attributed to the
sub-prime crises but left its impact on the world economies owing to
the forces of globalization and international trade. The downward trend
of the actual output of the trading nations of the west can be analyzed
from the macroeconomic tools of Aggregate Demand and Aggregate
Supply.
The tools of Aggregate Demand and Supply are widely used to explain
the fluctuations in the actual production across the economies. The
fluctuations in the output are usually accompanied by fluctuations in
the price level thereby causing inflation or deflation in the economy.
To understand how the tools can be utilized to understand the above
mentioned exercise, it is first essential to understand the basic
concepts of Aggregate Demand and Aggregate Supply.
2. Aggregate Demand
Prices and Aggregate Demand are negatively related for normal goods.
Source: courses.byui.edu
The downward slope of the demand curve depicts that the aggregate
spending by the economy declines at higher prices and also the
aggregate demand in the economy shows a rising trend with declining
prices. However, there are few effects at work that prompts the
demanders to behave in this manner. These effects are:
feel poorer than before and induces him to lower his spending. This is
called the Real Balanced Effect of a rise in the price level.
Rising prices has its impact on the interest rate that governs the
Investment demand and Supply. When the aggregate price level in the
economy increases, the demand of money for making a given
transaction increases. With money supply held constant, a shift in the
aggregate demand raises the price of money that is interest rate.
Since Investment constitutes a major component of the aggregate
demand, the AD-curve slopes downward.
AD = C + I + G; equation = 1
Where:
AD = 𝑪 + I + G + NX equation = 2
AD = 𝐶 + cYd + 𝐼 - bi + 𝐺 + 𝑁𝑋 equation = 3
Diagram
leads to a new AD curve marked as AD2. The curve AD2 lies to the
right of the AD1 curve indicating the higher aggregate demand
prevailing in the economy at the existing price P1.
3. Aggregate Supply
Aggregate Supply refers to all the goods and services that sellers in an
economy are willing to supply at a given price. The relation between
price and supply when considered at an individual or a microeconomic
level, then a linear positively sloped supply curve can be traced for a
major chunk of goods or services being supplied by the individual.
However, the nature of the aggregate supply curve is not that simple.
There are two schools of thought popularly called as Classicals and
Keynisians that promote the two differing slopes of aggregates supply
curve that can be observed for an economy.
Source: mmtwiki.org
Source: article.wn.com
The interaction of the short run and demand curve in the above figure
coincides at Point A in the figure. Point A determines the output level Y
and price level P for the given economy. However let us now look at
point B, which is the point of lower price and output. Corresponding
point B, the Aggregate Demand is much higher than AS at price Pe.
Since, the demand is higher, the consumers are willing and able to bid
higher price for the existing goods and services. This increasing the
profit margin for the suppliers leads to a positive supply shock till the
movement at the two curves leads to their interaction at the point of
equilibrium i.e., point A.
Similarly, let us now consider point B which lies at the vertical portion
or Classical Range of the AS curve. The curve is vertical at full-
employment level of output as indicated by YFE. Under such scenario, if
a positive shift in the aggregate demand occurs here from AD3 to AD4,
then there only occurs a rise in price from P3 to P4 while the real output
in the economy remains at the full employment level that is YFE.
Let us now consider the rightward shift in the AD curve when there
also occurs shifts in the vertical AS curve which can occur only when
the overall resources in the economy increases and thereby expands
Exercises
Ques.3 Discuss the features of short run and long run supply curve?
Ques.6 The quantity of real GDP available for sale in the market at various
prices is depicted by the
Ques.7 In the long run, at full employment level of aggregate supply, the
role of AD curve is to determine
I. Shift leftwards
II. Shift rightwards
III. No shift occurs
I. Real output
II. Prices
III. Real output and prices
I. Real output
II. Price
III. Real output and prices
Ques.10 A rise in labor costs employed in coal industry, causes the price of
coal to,
I. Increase
II. Decrease
III. Remain the same
References: