Aggregate Supply - Essay Example

AGGREGATE SUPPLY The Aggregate supply is defined as the amount of goods and services rendered by the national economy during particular time period. According to Keynesian economic model, two different versions are related to it, The aggregate supply in the Keynesian cross diagram is represented by Z curve. The curve is the representation of the total production launched by the country with reference to the total income gained. From the graph it is concluded that a straight line at an angle of 45o is drawn between the sum of income received and the sum of the production. If the desired total spending line 'bypasses the Z curve of aggregate supply' (Theory of Linear Economics), the intersection represents the level of production, spending and income. In some of the cases, the aggregate supply and aggregate demand curves are represented by Marshallian supply and demand curve. The curve of aggregate supply is shown increasing in upward direction, with slope parallel to the vertical axis. The upward slope of the aggregate supply is time bounded, and such behavior is prominent only for small time interval. The upward slope of the aggregate supply is because 'aggregate production and price level are directly proportional to each other' (Theory of Linear Economics). The direct relationship between the aggregate production and price level is because of, According to the neo classical economic model, the production can be increased if the prices of certain commodities are increased for wooing the profit oriented organizations. The reason behind increasing the production, and then subsequently increasing the prices is due to the diminished returns, and therefore the rise in marginal cost is forecasted because one or more production related factors remain stable in short run, and is considered to be at highest extreme, this is termed as fixed capital equipment. Taking into consideration the relationship between the income and production, during certain interval the income is fixed, and therefore the rising profit exemplify the expansion of output. However in case of the previous economic models, the income was subjected to vary with the economic conditions, and both the income and economic conditions share direct relationship. This theory is used to express the vertical behavior of the aggregate supply curve in long duration. Another model suggests that the economic behavior is dependent upon many non- uniformed and non- related input parameters. Those input parameters include both the labor and fixed capital accessory. However both the parameters can be unemployed, which has subsequent impact on the profit ratio. The positive slope of the AS curve is well explained with the reasons that, some input parameters are fixed priced on short term basis, and the production experiences resistance as it surges. When the demand of the production unit is lowered, the industrial units avoids optimized usage of their capital equipment, therefore keeping the average price level controlled, the production can be increased in case on minimized returns. Therefore 'flat AS curve is obtained' (Alternative Economic models of Transition). However if the demand factor surges, the production units have other unemployed input parameters, therefore the increase in demand and production increases the prices. Therefore AS curve is vertical. The practice of aggregate supply is normally implemented by the government for increasing the efficiency of production and over all national output. The government mainly applies the aggregate supply principle with the reforms in conformity of supply side policies. The government practices aggregate supply in different public institution including research and development, education and training, social welfare reforms, reforms associated with working class, minimizing the authority of trade union. AGGREGATE DEMAND The net demand of goods and services during particular time interval is termed Aggregate Demand. The individual curves sum up to give aggregate demand. The aggregate demand curve is the function of consumption, investment, exports, and government spending; unlike aggregate supply i.e. dependent upon the income and worth of production units. The fluctuating price level affects the overall behavior of aggregate demand. However in the case of aggregate demand, income and production were the major factors. There exist relationship between the above-mentioned economic factors; provided the price is constant, the relationship can be expressed in terms of effective demand. The Gross Domestic Product of the country i.e. the value of the country's earning is also related to aggregate demand. The influencing factors related to aggregate demand are further expressed as, 1. Consumption, the demand level of an individual, and is function of marginal propensity. 2. And disposable income. 3. Investment, the rate of investment is effected by the interest rate. The businessmen and multinationals are the key figures for bringing in investment. Investment is also function of the output. Investment varies directly proportional with the output, and has inverse relationship with the interest rate. 4. The government's expenses and consumption i.e. in forms of loans, aids, grant. 5. Export, where the output is sold at international price rate to other counterparts. According to Keynesian economic model, 'the investment is not only due to aggregate demand, rather investment varies with the fluctuation of demand' (The Theory of Linear Economic Model). However the investment i.e. planned or expected is purely the function of aggregate demand. The aggregate demand is function of variable quantities, therefore the formation of aggregate demand curve in income-output axis is tedious. However the curve formed can be expressed as follow, According to Keynesian model, the aggregate demand exhibits a linear behavior with positive slope, as the national output and income rise. The increasing slope is justified by the increase in investment, and tax revenues, and reduction in imports. The equilibrium is achieved once the spending and income are numerically equal. In case if the production level is lower than the equilibrium, the production is increased, thus equilibrium can be achieved. Conversely, if the level crosses the mark of equilibrium, then the production has exceeded, and therefore the inventories are closed i.e. economic activities are reduced. From Okun's Law, the equilibrium level of the output activities can assist the equilibrium level of employment. If the business activities are likely to gain momentum, and spending increases, and crosses the equilibrium. Similarly if business activities adopt sluggish behavior, then the spending reduces and equilibrium is not achieved. REFERENCES 1. John Marangos - Business & Economics., Alternative Economic Models of Transition 2. Marjan W. Hofkes, Jeroen C. J. M. van den Bergh - Business & Economics., Theory and Implementation of Economic Models for Sustainable Development 3. Robert Evans - Business & Economics., Macroeconomic Forecasting: Economic Models, Economic Policy and Science Studies 4. Brian S. Ferguson, G. C. Lim., Dynamic Economic Models in Discrete Time: Theory and Empirical Applications. 5. David Gale., The Theory of Linear Economic Models. Read More