Macroeconomics - Demand and Supply - Coursework Example

MACRO ECONOMICS Aggregate Demand Curve and Aggregate Supply Curve Abdulrahman Al-Kuwari ECO 201, Sec -006 Dr. Martin H. Sabo April 22, 2010 Macroeconomics develops and tests theories and underlying principles about the structure, performance and behavior of the economy as a whole and thus to help us predict the impacts of policies and events. Macroeconomics has always been a tool for Economists to help them understand how significant economic indicators like employment, production and income change over time. This paper concerns Macroeconomics and its two major functional areas that are Aggregate Demand and Aggregate Supply. This paper presents a detailed analysis on both Aggregate Demand Curve and Aggregate Supply Curve including the reasons for shifts as well. Introduction Macroeconomics is that field of study which is concerned with the structure, performance and behavior of the economy as a whole (Snowdon andVane p. 1). The factors which are taken into consideration during analysis of economy include growth issues, rate of inflation, unemployment, production of goods and services, general behavior of price, and so on (Snowdon and Vane p. 1). This research paper examines some important factors regarding macroeconomics including unemployment, inflation, factors of production and income distribution. Aggregate demand curve and aggregate supply curve are two of the most important terms associated with the field of macroeconomics. This paper focuses on these two areas of macroeconomics- Aggregate demand and Supply curves and the reasons for the shifting of aggregate demand and supply curves. Macroeconomics Macroeconomics is one of the two major branches of economics and it is related to the performance and structure of the economy of any country. Macroeconomics focuses on the behavior and activities of whole economy and is primarily concerned with various large scale indicators of economy which include inflation, production, and unemployment rates of any specific country (McEachern, P. 98). The study of these indicators is done by the macroeconomists in order to understand the functioning of the whole economy. According to Hughes and Perlman, unemployment is a very important phenomenon which is associated with the cyclical fluctuations. Unemployment rate is the ratio of the unemployed people to the size of the labor force size of a country (p. 1). Labor force of a country consists of those people who are either employed or looking for a job but not have yet been employed anywhere. Unemployment is never good for the economy of a country because unemployed workers are often associated with loss of output and decreased income of a country. Another significant indicator of a country’s economy is inflation which is related to the rate of change in the level of prices. Barro states that “by inflation, we mean a continuing upward movement in the general price level” (p. 237). Inflation is measured on a monthly basis when the rate of inflation is very high. Inflation rate is considered to be one of the most important forces of economy that is weighed consistently on the value of a country’s currency. Changes in the rate of inflation affect the economy of a country because when the rate of inflation will be high, consumer prices will also get high which will result in increased cost of living in the country (Snowdon and Vane, p. 3). Inflation is caused when the government of a country prints more than required money and experiences various financial crises. Inflation is considered to be one of the greatest threats not only to the purchasing power of the people but also to the economy of a country. Production is also one of the large scale indicators of a country’s economic strength. Production and economy of a country are directly and closely related to each other (Snowdon and Vane, p. 5). Greater the level of production by a country, stronger will be the economy of that country. It is because production results in increased income for a country. If a country has not got enough resources like labor force and raw material available for the production, the level of production can never get increased which results in decreased income for the country. Aggregate Demand Aggregate demand is the demand of goods and services within the economy at a specified price level. “Aggregate demand is the relationship between the average price of aggregate output in the economy and the quantity of aggregate output demanded”. (McEachern, p. 105). McConnell and Brue stated that aggregate demand is a schedule that shows the amounts of the real output that customers collectively are willing to purchase at a certain price level (p. 193). Aggregate demand is also known as the sum of expenditure over a given period of time. The formula used for the calculation of aggregate demand is: AD = C + I + G + (X – M) ‘C’ stands for consumer’s expenditure for goods and services which include consumer’s demand for durable and non-durable goods. Durable products include long-lasting products such as machines, furniture and cars. Whereas non-durable products include those products which need to be repurchased after they get used (Krugman, p. 425- 426). ‘I’ stands for investment spending that is the money spent by the companies in order to buy capital goods such as land, equipment and buildings. The investment which is done in the form of working capital is also included in investment spending (Taylor, 299). ‘G’ stands for government spending that is the money spent by the government in order to buy public and merit goods. ‘X’ stands for exports of goods and services. Those goods and services which are exported to other countries and organizations act as inflow of demand and result in increase in the aggregate demand. ‘M’ stands for Imports of goods and services which also increase the expenditure because the money gets spent in order to buy goods and services from some other country. So as it is the flow of money out of the economy, it is also added to the expenditures (Taylor, 299- 301). Aggregate Demand Curve The aggregate demand curve shows the relationship that exists between the price level and the GDP of the economy. The aggregate demand curve is usually measured in terms of consumer price index (Krugman, p. 425). The factors which cause a change in the curve include changes in expectations, changes in monetary policy, changes in fiscal policy, various economic events, and changes in household wealth (Krugman, p. 425). A contraction in the aggregate demand curve is caused when the general price rises whereas suspension in the aggregate demand curve is caused when the general price falls down (Krugman, p. 425). Downward shift in the aggregate demand curve is caused due to rise in the price levels. The reasons for the downward shift include unaffordable goods and services due to less income, unbalanced trade due to rise in imports, and rise in interest rates due to increase in the demand for money. These shifts are not good for a country’s economy because fluctuations are caused in the economy’s output and the overall price level also gets affected (Mankiw, p. 459). Aggregate Supply Aggregate supply is the total number of goods and services that the companies tend to sell in any specific country at a specified price level (McConnel and Brue, p. 197). The ability of an economy to produce goods and services in order to sell them in a given time period is also termed as aggregate supply (Gillespie, p. 300). Aggregate supply is represented by the aggregate supply curve which shows the relationship between production and the price levels (McConnel and Brue, p. 197). The two most important factors which should be considered while determining the aggregate supply in any specific country include actual production of goods and services within the macroeconomic environment of the country and the cost of producing those goods and services. These two factors must be taken into consideration in order to determine the accurate aggregate supply within the country (Mankiw, p. 752). Aggregate Supply Curves In short run aggregate supply, wages and the state of technology don’t get changed regardless of the changes in prices in the economy. The curve in the short run aggregate supply remains almost horizontal. Reasons for shifts in the short run aggregate supply include changes in the wages, changes in the costs of raw material, and changes in producers and subsidies (McConnel and Brue, p. 199, Mankiw, p. 752). In long run aggregate supply, the ability of a country to produce goods and services is based on two factors which are availability of factor inputs and state of technology. Reasons for shifts in the long run aggregate supply include changes in the natural rate of growth of output, increased productivity, and an increase in the stock of capitals (Mankiw, p. 752). Conclusion Summing it up, it can be said that strong and stable economy is of crucial importance for the development of a country. Macroeconomics can be analyzed by primarily looking at rate of inflation in the economy, unemployment conditions, and production and national income of a country. Aggregate demand and aggregate supply are the two most important issues in macroeconomics which should be properly analyzed by the macroeconomists in order to develop a stable economy. My Opinion regarding Macroeconomics Macroeconomics is a very important part of economics which should be considered and properly analyzed by the government of a country while setting up economic policies for the development of economy of the country. Such mechanisms should be applied by the governments which should be able to maintain a balance between the aggregate demand and aggregate supply in the economy in order to keep the economy strong and stable. Suggested Areas for Further Research I would suggest further research and detailed studies on each and every aspects of why and how far inflation can have direct impact on aggregate demand curve and aggregate supply curve. The inflation and its economic impacts on both aggregate demand and aggregate supply curves are to be further developed, studied and researched based on empirical analysis and current economic factors. In order to conduct further research on the inflation and aggregate demand and supply relationship, various well known literatures as well as journals can be depended. Works Cited Barro, Robert J. Macroeconomics. 5th ed. U.S.A: The MIT Press, 1997. Gillespie A, Foundations of Economics, Illustrated edition, Oxford University Press, 2007, p. 300 – 304 Hughes J.J and Perlman R, The economics of unemployment: a comparative analysis of Britain and the United States, Cambridge University Press, 1984 Krugman, International economics: theory and policy, Eighth Edition, Pearson Education India, P. 430 - 440 McConnell and Brue, Economics, Sixteenth Edition, The McGraw Hill Companies, 2004, p. 193 – 200 McEachern W.A, Macroeconomics: A Contemporary Introduction, Illustrated Edition, Cengage Learning, 2008, p. 98- 106 Mankiw N G, Principles of Macroeconomics, Fifth illustrated edition, Cengage Learning, 2007, P. 741- 747 Snowdon B and Vane H.R, Modern macroeconomics: its origins, development and current state, Illustrated edition, Edward Elgar Publishing, 25, p. 1- 5 Taylor J, Principles of Macroeconomics, Fifth edition, Cengage Learning, 2006, P. 297- 302 Read More