The AS and AD Models - Essay Example

? Economic Models Economic Models In the AS/AD model, consider an economy where the level of production is below the natural level The term aggregate demand and supply are economic models, which are closely associated with levels of prices and the actual production that is instrumental in the analysis of business cycle, unemployment, gross domestic production, inflation, and the stabilization policies of an economy. The aggregate supply and demand model is dictated by the standard of the models in the market. This captures the level of interaction between the buyer and the seller in both the long and short-term model. In the economy, there is a great relationship between the demand and the supply in the market. The fluctuation of one greatly affects the balance of the other. For instance, it is traditionally known that whenever the level of demand is high, there would be an automatic increase in price to contain the equilibrium in the market (Cohn 2007). The case is vice versa when there is low demand. The demand of commodities in the market is low, and then the prices would be lower to attract more buyers. The AS/AD model explains this phenomenal to an understandable degree of agreement between the market dynamics. Demand, in o5ther economic terms is explained as the quantity of goods a population is willing to purchase in an economy at a particular price. On the other hand, supply is the amount a market can offer to its people. The law of the demand in a market dictates that, the higher the price, the lower the demand of goods and services in a specific market. The opportunity cost of buying the goods goes higher because people would have other preferences in their decision. It is most apparent that people would look for other alternative means when the prices in the market are not favorable. The law of supply also has a great determination in the market. This law dictates that, when the prices are high, there are high supplies in the market. This is because suppliers seek the opportunity to make more profit when the prices are high. The Aggregate supply and demand graph When the supply and the level of production are lower than the natural level, then the economy is bound to suffer. This would mean that the level of gross domestic product of a country is low. This would mean that the government would not be in a position of raising enough capital to fund its endeavors. When the level of production goes below the natural levels, the rate of unemployment would also rise. A number of people would be laid off because the government would not be in a position of maintaining. The impact of reduced GDP would further pose many challenges in the economy. People’s welfare would not be adequately looked into and the government would neglect their wellbeing. Prices of goods are bound to increase in such a situation. The prices would take the effect of the law of demand, but this would further pose challenge to the economy of the state. When the supply is low, people are not willing to pay more for the goods, and services would further make suppliers and investors hard time in supplying the economy. This is a major setback. In a situation where people are not willing to supply the market due to poor prices and at the same time, people do not have resource to buy the products in the market. The situation should not be like this in any economy. The adjustment process in the economy It is a natural phenomenon that people and situations would always resist change but rather choose to be comfortable with the normal. However, not every market is marked with an absolute degree of permanency. A time comes when things have to change. Things have to be done in a new way to enable the market of the economy to take care of the ever-increasing value and demands of humanity. In every day’s market, prices are bound to change; the quality and quantities in the market fluctuate. The first cause of the market adjustment is the determinant. The determinant of a market adjustment could be supply or the demand as dictated by the market. The demand and the supply cause changes in the demand and supply respectively. This shift in the curve is what is responsible in throwing the market out of balance. The shift in the curves thus causes disruption in the equilibrium, resulting to either surplus in the market or surplus. Way, either an increase in the demand of a commodity or a decrease in supply would automatically create shortage in the market. On the other hand, when there is a decrease of the demand commodities, and an increase of supply of commodities in the market, this would result in excess commodity in the market (Colander, & Gamber 2006). This imbalance in the market where an increase in supply causing excess in the market would dictate that the prices have to change in the market to accommodate the shift of equilibrium. When the prices of commodities are forced to change will result in both the change of the quantities of commodities that are to be supplied in the market. The changes that occur in the demand of goods supplied in the market helps in the elimination of the imbalance that is in the market. The prices are bound to change in the market with the shortage or the surplus in the market. Suggest a fiscal policy to increase output The best fiscal policy that aid in increasing output in an economy best is the Monetary Policy. The monitory policy boils to the level of increasing and regulating the supply of money to ensure that there is a controlled measure of inflation and the stability of the output in a specific economy. It is worth noting that, the output in any economy, which is always the GDP, is often constant. It is also true that, the supply of money would considerably affect the prices of commodities in the market. This is possible in the end. In the short run, due to the gradual changing nature of prices, an increase in money supply would largely affect the production of goods and services. Monetary policy stands to be the best mechanism through which inflation and growth objectives could be achieved. For example, in a situation where there is recession, there is a large decrease in spending leading to the decline in production. This process leads to the lay-offs by companies because they cannot afford to pay employees effectively. At such a time, the economy and individuals in such an economy may not even buy from the foreign markets because of lack of capital. To restore the economy and enable business to proceed well, then the government remains with the option of monetary policy to salvage the situation that can destructively affect the economy of the state. This policy would mean that there is to maintain human expertise and employment. This will enable the economy of the country to stand. However, because this policy involves the supply on money in the economy, it would automatically result in increase in prices to enable the local economy to be at par with the world economic rates. This fiscal economic policy has adverse effect on the rate of employment and fiscal deficit. The monitory policy is often altered to accommodate the demands in the market. This is done by taking care of the amount of money supplied in the market. This is often done by the central bank. The policy is executed through the open market system where the where the debts of the government are exchanged with the private sectors only in the short term. When central banks release money to the market, the interest is not how the given amount would affect the price but rather how the total amount given out to the economy would earn interest. The central banks have opted for this measure because quantifying the value of money with the effects they have on price change of commodities in the market is challenging and not easy to achieve. Another fiscal policy that may be applied by the government is the tax policy, which takes a description of two actions taken by the government to ensure that the economy remains stable at all times. By taxing people, the government is often assured of raising revenue from the population in the country. The government tax people for different reasons. Through the taxes that the government raises from people, the government manages to foot its expenditures. Additionally, people transfer their assets to the government through this sure way (Michl 2002). Through taxation, the national output is increased since the government can adequately take control of the economic situation of the country. The government is seriously concerned with stabilizing the economy, it thus apply different types of fiscal policies to ensure that this is achieved. Since the government has control over the taxes levied to release the populace and the amount of money that is to the market. The government can ensure that there is stability in the economy to enable the expansion of output by lowering the prices and raising the level of government expenditures. The government ensures that the level of production remains at equilibrium with natural level or it moves higher than the natural. Bibliography Cohn, S. (2007). Reintroducing macroeconomics: A critical approach. Armonk, NY [u.a.: Sharpe. Colander, D. C., & Gamber, E. (2006). Macroeconomics. Cape Town: Pearson/Prentice Hall. Michl, T. R. (2002). Macroeconomic theory: A short course. Armonk (N.Y.: M.E. 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