MACROECONOMICS

BY LENFORD

STUDENT ID NUMBER:

SECOND ASSIGNMENT
Table of contents

Introduction………………………………………………..…………………………………3

Aggregate supply……………………………………………………….……………………3

Aggregate supply over the short and long run……………………………….………………4

A graph of short run aggregate supply………………………………………………………5

Aggregate demand………………………………………………….………………………..6

Requirements of demand…………………………………………………………………….6

The graph of aggregate demand……………………………………………………………..7

Graph for the equilibrium…………………………………………………………………...8

Gross domestic product in real and potential…………………………….…………………8

Inflactuations……………………………………………………….………….……………9

Methods for decreasing the inflation and recession gap…………………………...……….11

Conclusion………………………………………………………………………………….11

References…………………………………………………………………………………..13
Introduction

Aggregate supply and demand are two of the key concepts in macroeconomics that we are
expected to comprehend and be familiar with. According to Dutt, A. K. (2006), “the whole
supply of products and services produced within an economy at a specific overall price over a
specific time period is known as aggregate supply, also known as total output”. The aggregate
supply curve shows the connection between price levels and the volume of output that firms are
willing to generate. The total supply and price level typically have a positive connection. The
aggregate supply is often calculated over a year because supply changes typically follow demand
variations.

The two categories into which aggregate supply is separated are long-run aggregate supply
(LAS) and short-run aggregate supply (SAS). The period during which real GDP has fallen or
increased relative to potential GDP is known as the short-run aggregate supply. Since changes in
aggregate demand only temporarily affect the economy's overall production, the long-run
aggregate supply curve is vertical.

According to Barro, R. J. (1994), the term "aggregate demand" is used in macroeconomics to

refer to “the overall demand for commodities produced domestically, including capital goods,
consumer goods, and services”.

Things rarely move smoothly in economies, which means there may be fluctuations like
inflation, recession, and stagnation. This essay will clarify how the intersection of Aggregate
demand and supply determines real gross domestic product (GDP 0as well as the equilibrium
price index. Additionally, it will discuss some of the most significant swings and how these
changes might be made to preserve financial stability.

Aggregate supply

Aggregate supply, as was previously said, refers to the total number of goods and services
available at a certain market inside a country. To meet the growing total demand, corporations
frequently need to increase production, which is often indicated by rising pricing. When demand
increases despite stable supply, consumers compete for the available goods and pay more. This
dynamic causes businesses to raise output to boost sales. Because of the additional supply, prices
stabilize while output remains high.

 Dornbusch, R., Fischer, S., & Startz, R. (2011) stressed that “a change in aggregate supply can
be ascribed to several factors, such as shifts in the quantity and quality of labor, technical
advancements, salary increases, production cost increases, producer tax changes, producer
subsidy changes, and changes in inflation”. While some of these factors lead to an increase in
aggregate supply, others lead to a drop. For instance, increased labor efficiency—possibly
attained through outsourcing or automation—raises supply production by lowering the labor cost
per unit of supply. On the other hand, wage increases raise production costs, which reduces
supply overall.

Aggregate Supply Over the Short and Long Run

The aggregate supply uses a larger portion of current inputs in the production process as a result
of short-term increases in demand (and pricing). Because the level of capital is fixed, a firm, for
instance, cannot immediately develop a new facility or introduce a new technology to increase
production efficiency. Rather, the company expands supply by more effectively utilizing its
current production resources, for as by increasing labor hours or making better use of already-
existing technologies.

The aggregate supply, on the other hand, is only impacted by advances in productivity and
efficiency in the long run, not by price levels. These innovations involve improvements in
worker skill and education levels, a growth in capital, and technological advancements. Many
economic theories, such as the Keynesian theory, contend that the aggregate supply will continue
to exhibit some degree of price elasticity in the long run. When you cross this point, supply no
longer responds to changes in price.
A graph of short run aggregate supply

general
price level
Gpl 2 c

Gpl 1 b

Gpl 3 a

d3 e1 f2
NB:
  The upward slope of the SAS curve indicates rising product pricing. Profits are
generated, and the supply of real GD rises as a result.
 The downward arrow denotes a decline in the price level, which results in a contraction
of the total supply.

Aggregate demand

The term "aggregate demand" is typically used in macroeconomics to refer to the entire demand
for domestically produced commodities, including capital goods, consumer products, and
services. It includes all purchases made by people, companies, the government, and foreigners
(through exports), minus the percentage of demand satisfied by imports from other nations.

The value of a commodity always causes the aggregate demand curve to alter (shift). The ability
of people to shop for goods and services declines when commodity prices rise. This causes
customers to occasionally have a genuine savings balance, which lowers their consumption.

Requirements of demand 

Price is the primary element that causes the aggregate curve to move, although occasionally,
other factors, are such as;

 Consumer Wealth: The main components of consumer wealth are their financial and
material possessions. Consumer wealth increases, which implies a growth in demand for
goods and services. As a result, the demand curve is corrected, causing the $64,000 gross
domestic product (GDP) to grow.
 Taxes: If the government. imposes high taxes and rates, which causes the demand curve
to move to the left and lowers the gross domestic product by $64,000.
 Real Interest Rates: The demand curve swings to the left when banks and other domestic
financial institutions provide high interest rates, depressing real gross domestic product
because consumer spending is low. When factors that influence demand, such as
consumer affluence, rise, taxes fall. At the equilibrium price, real interest rates decline,
while real GDP and consumer income rise.
 The graph for aggregate demand

125 EX
Price level

115 D X

105 C X
Decrease in the quantity of real GDP
Demanded
95 B X

85 A X AD (Downward slope)
 0 9.0 9.5 10.0 10.5 11.0 11.5 12.0

Graph for the equilibrium

Gross domestic product in real and potential 

Real gross domestic product 

This macroeconomic measure of economic output's value has been modified to account for price
variations. Inflation or deflation might serve as an illustration of this. Gross Domestic product
(GDP), a measure of economic worth, is adjusted to create an index of the total amount of
output.

Potential gross domestic product 

The market's current pricing is used to value the output. The nominal gross domestic product
(GDP) is not adjusted for inflation, in contrast to the real GDP.
Real GDP and normal GDP measurement

The deflector for GDP

It is a technique used to gauge the market's total pricing levels.

NORMINAL GDP
GDP DEFLACTOR=100 ×
REAL GDP

Inflactuations

Inflation

This could happen if a nation's money supply grows more quickly than its potential GDP. This
increases demand more broadly than it increases supply. When there is an excess of money
chasing an inadequate quantity of goods, inflation results. There is no balance between the two
curves in this case since the aggregate supply curve swings to the right faster than the LAS
curve.

Inflationary gap

Demand for goods and services outpaces supply when inflation occurs. This is due to either
excessive unemployment or increased government spending. As a result, the GDP of $64,000 is
higher than the GDP that might be produced; this discrepancy is known as the inflation gap.
People now have enough money to spend as a result of this.

The graph of inflationary gap

Price level
LRAS
PLe1 B SRAS

Ple A
 AD

AD
Y1 Y REAL GDP

Recession
Recession is a particular kind of economic turmoil that fluctuates from year to year based on how
the overall state of the economy is going. It is also noted as a period of declining real incomes
and rising unemployment. Depression results from the situation getting worse during a severe
recession.

Graph showing a recession gap

LRAS
PRICE LEVEL SRAS

Ple A
 Ple 1 B AD

AD
Y1 Y REAL GDP
NB:
Recession is brought on by a number of circumstances, including a weak economy, low levels of
employment, a higher-than-average employment rate, and declining prices.
Methods for decreasing the inflation and recession gap
fiscal strategy
These are government-created policies. Influencing economic activity is the goal. Governments
can lower tax rates or raise spending to pay for people or services when a recession is present.
Since a tax cut boosts household income, which in turn boosts people's demand for goods and
services and moves the demand curve to the right, it may help people understand their financial
situation or at least have some income. The government can raise tax rates and cut spending
across all industrial sectors when there is inflation.
Monetary strategy
These are the adjustments to the price per unit and the amount of money that the government or
financial institution controls. To stretch aggregate demand and trigger the aggregate curve to
shift to the right during a recession, financial institutions can boost cash balances and lower
interest rates. Instead of raising the supply of money when there is inflation, central banks reduce
it and give high interest rates.
Stagnation
The worst aspect of fluctuations is stagflation. It consists of both recessions and inflation.
Inflation happens when the money supply is expanding more quickly than the potential GDP.
This raises consumer demand, which results in lots of money being spent to chase after fewer
things. On the other side, when the government tries to remedy things, they might mistakenly
believe that there has been a decrease in supply, which leads to stagflation. Even if the economy
occasionally may find its own method to handle stagflation, the government and financial
institutions may try by making sure they address the situation while it is in an inflationary or
recessionary stage. They must exercise caution because a misunderstanding of those two could
result in disaster.

Conclusion
After covering this ground, the paper can draw the conclusion that aggregate supply and demand
are essential elements for understanding the interactions between buyers and sellers of goods and
services within the economy. They demonstrate how real gross domestic product (GDP) and
equilibrium price levels are calculated. However, despite the fact that these features are planned,
errors inevitably occur and are referred to as fluctuations. These fluctuations are essential to the
economy, but if they are understood, they can be managed and help stabilize it.
References

Abel, Andrew B., Olivier J. Blanchard, Ben Bernanke, and Dean Croushore. Macroeconomics.
Pearson UK, 2017.

Barro, R. J. (1994). The aggregate-supply/aggregate-demand model. Eastern Economic Journal,

20(1), 1-6.

Dornbusch, R., Fischer, S., & Startz, R. (2011). Macroeconomics. McGraw-Hill.

Dutt, A. K. (2006). Aggregate demand, aggregate supply and economic growth. International
review of applied economics, 20(3), 319-336.

Mitchell, W., Wray, L. R., & Watts, M. (2019). Macroeconomics. Bloomsbury Publishing.

Slavin, S. L. (2006). Macroeconomics. McGraw-Hill Companies.