The aggregate demand – aggregate supply model is used by economists to analyze the behavior of the macroeconomy in both the short run and the long run and aggregate demand in general refers to total spending by households, businesses, governments, and foreigners on domestically produced final goods and services. The aggregate demand curve (AD) describes the behavior of buyers of final goods and services in the aggregate. The aggregate demand – aggregate supply model allows us to see what factors influence prices and real output in the short-run, or as the economy proceeds through the business cycle. And now we will see how the aggregate demand effects economy in the short run by analyze the ...view middle of the document...
” Firms can convince some workers to work overtime or can entice some people who are not normally part of the labor force, like housewives and retired people, to work, but such efforts will not yield much. Further any increases in production are temporary because costs will begin to rise and push production back toward the natural level in the medium-run. Because this inflation is due to increases in aggregate demand, it is called demand-pull inflation.
After analyzing the changes in the aggregate demand that can move the economy through the business cycle, the government will come up with discretionary or countercyclical fiscal and monetary policy to help the macroeconomy achieve the natural level of output with low inflation in the short-run.
Discretionary or Countercyclical Fiscal Policy – deliberate changes in federal government spending or taxes to control production and employment or demand-pull inflation. Changes in spending and taxes at the federal level require that Congress pass legislation and that the president sign it. The actual spending plans and taxation are carried out by the US Department of the Treasury.
Problem: Demand-Pull Inflation because aggregate demand has increased too much or too quickly, as illustrated in the following diagram.
SRAS INFL2 = 7%
INFL1= 2% AD’
Policy goal: Reduce aggregate demand. Policy action: Contractionary Fiscal Policy
Problem: Recession because aggregate demand is decreasing or is too low resulting in production falling below the natural level, as illustrated in the following diagram.
y1 yn y
Policy goal: ...