Accomplishing the four goals of macroeconomics at the same time is tricky and the aggregate supply/aggregate demand model is a good way to look at this relationship
Aggregate supply is the total amount of goods and services produced in an economy at a given overall price at a given time level limited by potential GDP(potential GDP is the state where all people are employed and all machines and materials are in full use
- It is limited by potential GDP(potential GDP is the state where all people are employed and all machines and materials are in full use
- Productive potential tends to grow at a rate of 2-3%
- ….among others, it’s as a result of new innovations
- However, certain conditions can influence the entire chain, such as energy costs
- Aggregate demand is the total amount of goods and services demanded in the economy at a given overall price level in a given time period
Aggregate supply must equal aggregate demand; however, there are differing theories which account for the way they operate. They are Say’s law and Keynes’ law
Say’s law says that production is the source of demand
- Or, supply creates its own demand, the neoclassical economist would say, because….
- …..every sale is income for someone(s)
- There are a few questions which arise, why are there recessions if you can just supply things, and why would an economy shrink
Keynes’s law states that demand is the source of supply
- The economy will find itself at times with unemployed workers and product just lying around. They feel there just needs to be demand stimulation ….
- This is done by lowering taxes or providing subsidies and when the economy gets to grow “too much” then enact taxes and fees to depress the economy.
- Why doesn’t the Gov’t just stimulate to the countries content, there never has to be recessions
- There are limits to supply, however, which could bridle stimulation and could increase the rate of inflation
- This is the basis for Keynesian economics
Due to fluctuations in consumer confidence and investing and business behavior coupled with the fact that wages/prices tend to be sticky(inelastic) aggregate demand may lag behind in the short run
Companies want a relatively quick turnaround when buying and selling
- If not they back log projects
- Then strike with many jobs when the time is right
- In the 90’s a new information medium, the internet, emerged and with it, a flood of investments but in the 2000’s investments have slowed from the initial flurry.
- In the long run, however, aggregate supply determines the size of the economy with the occasional run ahead or behind of aggregate demand to create a recession or inflation.