# 11.2 Building a model of aggregate demand and aggregate supply  (Page 4/24)

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## Equilibrium in the aggregate demand/aggregate supply model

The intersection of the aggregate supply and aggregate demand curves shows the equilibrium level of real GDP and the equilibrium price level in the economy. At a relatively low price level for output, firms have little incentive to produce, although consumers would be willing to purchase a high quantity. As the price level for outputs rises, aggregate supply rises and aggregate demand falls until the equilibrium point is reached.

[link] combines the AS curve from [link] and the AD curve from [link] and places them both on a single diagram. In this example, the equilibrium point occurs at point E, at a price level of 90 and an output level of 8,800.

Confusion sometimes arises between the aggregate supply and aggregate demand model and the microeconomic analysis of demand and supply in particular markets for goods, services, labor, and capital. Read the following Clear It Up feature to gain an understanding of whether AS and AD are macro or micro.

## Are as and ad macro or micro?

These aggregate supply and aggregate demand model and the microeconomic analysis of demand and supply in particular markets for goods, services, labor, and capital have a superficial resemblance, but they also have many underlying differences.

For example, the vertical and horizontal axes have distinctly different meanings in macroeconomic and microeconomic diagrams. The vertical axis of a microeconomic demand and supply diagram expresses a price (or wage or rate of return) for an individual good or service. This price is implicitly relative: it is intended to be compared with the prices of other products (for example, the price of pizza relative to the price of fried chicken). In contrast, the vertical axis of an aggregate supply and aggregate demand diagram expresses the level of a price index like the Consumer Price Index or the GDP deflator—combining a wide array of prices from across the economy. The price level is absolute: it is not intended to be compared to any other prices since it is essentially the average price of all products in an economy. The horizontal axis of a microeconomic supply and demand curve measures the quantity of a particular good or service. In contrast, the horizontal axis of the aggregate demand and aggregate supply diagram measures GDP, which is the sum of all the final goods and services produced in the economy, not the quantity in a specific market.

In addition, the economic reasons for the shapes of the curves in the macroeconomic model are different from the reasons behind the shapes of the curves in microeconomic models. Demand curves for individual goods or services slope down primarily because of the existence of substitute goods, not the wealth effects, interest rate, and foreign price effects associated with aggregate demand curves. The slopes of individual supply and demand curves can have a variety of different slopes, depending on the extent to which quantity demanded and quantity supplied react to price in that specific market, but the slopes of the AS and AD curves are much the same in every diagram (although as we shall see in later chapters, short-run and long-run perspectives will emphasize different parts of the AS curve).

In short, just because the AD/AS diagram has two lines that cross, do not assume that it is the same as every other diagram where two lines cross. The intuitions and meanings of the macro and micro diagrams are only distant cousins from different branches of the economics family tree.

can unemployment be a factor of inflation?
microeconomics is individual firms and macroeconomics is a large as a full
That's true 👍
Kwibuka
word micro means small and tiny part. word macro means large and big part.
Exactly
Emmanuel
is unemployment another cause of inflation?
David
can I say unemployment can cause inflation?
David
no. unemployment can possibly lead to deflation
Asdfghjkl
if their are no production am I correct to say inflation will occurs
David
one of the causes of inflation is excess demand. if there's no production there would be no demand so no inflation
Asdfghjkl
if we take a look at inflation, it occur because of low production. High price chasing few goods.
David
So are you saying demand creates supply?
David
to an extent because if s9mething is demanded, it's likely to be supplied
Asdfghjkl
OK am still confused, if there is unemployment low production, and employment high production, inflation high increase in price, how can production be high and we are faced with inflation? When inflation is referred to higher price chasing few goods.
David
if the demand is increased , what is the graphics on it?
what is macroeconomics
large-scale economics, such as interest rates or the gross national national product rate of of a country
Michael
Macroeconomics: is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies.
well said
Michael
hello everyone, would like to ask a favor... i need your help to answer this problem: Assume that equilibrium GDP is 400B; potential GDP is 500B, the marginal propensity to consume is 9/10, the interest rate is 8%, investment spending is P20B, the money supply is 120B, and the reserve requirement
Jerelyn
is 1/10. By how much and in what direction should the Fed change the monetary base?
Jerelyn
what are the factors that influence surplus budget? and its effects
what is credit creation
Christopher
join
Christopher
how monetary and fiscal policy affect money supply? on economy
what is hyperinflation
what is stagflation
Riaz
in an economy when there is both inflation & unemployment prevailing at the same time.
Yogesh
@david - hyperinflation is very rapid inflation; it is sometimes reckoned to set in when price increases exceed 50 percent per month. Such rapid inflation not merely makes money useless as a store of value, but seriously affects its use as a medium of exchange
sagar
thanks
Riaz
@yogesh: the one you are describing is Stagflation
Tutohar
I was answering to Riaz's querry.
Yogesh
Sorry, didn't see the question
Tutohar
what is credit creation?
Christopher
what are the factors that influencing surplus budget
Christopher
may I ask master level questions on this chat?
yes
deepali
am so confused about the concept of scarcity. can u hlp me
· Concepts of Scarcity. Scarcity refers to the condition of insufficiency where the human beings are incapable to fulfill their wants in sufficient manner. In other words, it is a situation of fewer resources in comparison to unlimited human wants. Human wants are unlimited.
Shittu
what is PPC
Kalpana
the aggregate expenditure function determines a specific national equilibrium income. substantiate graphically noting the sheets where applicable
formula of economics
Sagar Dey..? That thread reached to its limit
100msg in one conversation
What is exogenous spending.. In the context of export function?
@BRB - this reply is in context of your last post in our previous conversation.
sagar
@BRB - I was unaware of the fact that we require Maths in our intermediate for doing our post graduate in Economics from JNU. I am a student here in Sociology. I have attended the classes of Economics here but nobody ever told me about this. I think you must recheck the criteria again.
sagar
@BRB - you can also try in Jamia Islamia University, Hyderabad University, Jadavpur University, Ambedkar University. If you want to opt for distance learning IGNOU is a fantastic choice for that. My second M.A, which is in Economics, is from IGNOU.
sagar
@BRB- If you can afford to study in abroad, you can try, at least once, for LSE (London School of Economics). You have to appear in IELTS for scholarships first.
sagar
@BRB - Ravenshaw University in Cuttack is also known for its courses in Economics.
sagar
@subhadra - give me statement about exogenous spending. An exogenous variable is generally a variable not related to other economic variables in the system under consideration by causal links but determined by factors outside the system.
sagar
@sagar- Thanks I already checked the eligibility criteria to take admission in JNU, DSE, Kurukhatra University and IIT in khadagpur or Hyderabad. In it Math is essential in +2 level to take admission only in economics.
BRB
How much a country can export depends upon the spending decisions made by the foreign households and firms that purchase domestic good and services
Thus exports are influenced by the outside forces or exogenous spending.
@subhadra here exogenous refers to the factors which are present outside the country. For example, India can increase its export of Alphonso Mango only if the factories in European countries are willing to make products related to Alphonso Mangoes & the households in Europe are willing to buy them.
sagar
Okay got it
what is inflation
inflation is the continuous/persistent increase in the general price level of goods and services.
kambisony
inflammation is a market situation, in which the price level increase and the value of goods decrease.
giri
Dav
Kalpana
How does money get into the economy?
In modern society money is circulated in the economy by the apex banks of different countries. In the case of India, it is the RBI and in the case of USA it is the FED which execute this function. The money circulated by them is called 'legal tender' because of its acceptability in trade & commerce
sagar
Banks are the institution which facilitates the process of circulation of not only cash but also plastic money in the economy.
sagar
Thank you Sagar Dey.. Can you explain me about legal tender.. With example
Loans & Withdrawals are the primary means through which money gets out of the bank and enters our pocket. When we spend it in the market it comes into motion.
sagar
Ok. Thank you
Forms of money which a creditor is obliged to accept in settlement of a debt can be considered as a legal tender. I am not obliged to accept cheque from you if you trade with me. Hence, a cheque is not a legal tender.
sagar
In ancient period people used to trade in commodities, such as, apples, flour etc. Over time the system of Barter caused several inconveniences. Consequently, gold coins, because of its durability, became the accepted medium of exchange. But gold too had its limitations & were misused by the thugs.
sagar
That means any form of money but should be acceptable!
Therefore, an alternative was sought. And coins & banknotes guaranteed by the governments became the legal tender. The rule that makes something a legal tender is the "matter of convenience"
sagar
During the demonetization in India the GOI went against the promise which it makes in every note, that says, "mai dharak ko .... paise ka wachan deta hu". As a result, notes worth 500 & 1000 ceased to remain legal tenders.
sagar
When the new notes were introduced it was convenient for the masses to use them. Hence, the new notes became the legal tender.
sagar
Ya, you got it. Any form of money which has its acceptability becomes a legal tender. Cash is the most liquid asset which makes it the most acceptable form of money. On the contrary,cheque or electronic transfer is not feasible everywhere(villages and in every shop),hence, they are not legal tenders
sagar
If cheques are legal tender in urban areas?
thank you sagar dey
Aman
nope, you are not obligated to accept my cheque if I trade with you. You can compel me to pay in cash.
sagar
@aman - No problem dear ... Take care
sagar
Ok.. Thank you so much
sagar
Could you tell me please.. What's the difference between demand deposits and savings?
Or they are same
my English is not proper so i need hindi language if possible pl . give me suggestions in hindi
Kalpana
for money creation by the demand deposit miltiplier
Venkata
@subhadra @kalpana Banks me 2 tarah ke deposits kiye jaate h-Demand aur Time. Time deposit ka udaharan Fixed Deposit hota hai jo k ek diye gye samay k baad hi nikala jaa sakta hai. Agar diye hue samay se pehle nikale to bank me paise rakhne ka laabh, interest k roop me jo milta hai, woh nahi milega
sagar
Demand deposit ka udaharan Current aur Savings account hai. Inme Fixed Deposit se kam interest milta hai kyunki aap jab chahe paise nikaal sakte hai.
sagar
thanks alot sir
Kalpana
thanks all of u
Farsa
@kalpana - you're welcome... but I ain't Sir... mai koi sir nahi hu.
sagar
@farsa - you're most welcome dear
sagar
what is plastic money
Rohit
@rohit - debit card, credit card et cetera
sagar
if the central banks can't regulate the value of a money on a certain country. what policy will be applied to maintain the inflation rate of thet country?
fiscal policy measures, that is the government reduces the expendures
Joel
thanks mr. joel Ephraim. but still i did't get enough answer...any one else
when the gvt reduces the expenditures the supply of money decreases in the circulation thats when inflation is controlled... also taxation, wage minimization are the measures that the gvt takes to reduce the supply of money so as to control inflation
Joel
nice
partially you answered my question. but not completely
what is supply of money? and how government doing it?
Mehmood
Hassan read about monetary policy and you will know about money supply and how government controls it supply using central bank and fiscal policy
Felix
Thank you Sagar ji
Why current account balance and capital account balance should always be zero?
@subhadra - It is zero at the end because we follow Double Entry System of Book Keeping while accounting the trades in BOP. This system of book keeping is a subject matter of accounts. However, Zero doesn't mean that BOP is in equilibrium. The surplus or the deficit element is mentioned at the end
sagar
of either the current account or the capital account. And it is used while beginning a new BOP account in the next year.
sagar
Oh.. Yes the double entry book keeping.. Got it
Kingsley
Nobody can enlighten you except yourself. As far as information is concerned, Macroeconomics deal with the economy as a whole, unlike Microeconomics that deals with a single unit - household, individual, company et cetera.
sagar
Thanks
Kingsley
by buying what ever is sold but first it has to be printed by the mint companyand handed out by the bank and of course in order to buy things you have to have a paying job
Fuf
basically for the most part buying and selling and the food market id great for that in our economy gotta keep consumers happy
Fuf
Thanks
Francis
alayo
Investment depends upon two prime factors as rate of interest and MEC ... MEC is the rate of return the business people expect to earn from new investment i.e purchase of new capital goods. It too depends on two factors, namely:- Rate of depreciation of a commodity and...
BRB
Replacement cost of old capital goods or purchase of new capital goods. Okay
BRB
MEC also called the Profit expectations of business firms ...
BRB
In the short run interest rate remains constant so that Investment occurs due to MEC... In the short run, moreover, Replacement cost of old capital goods are constant, hence depreciation rate merely create MEC as a whole .
BRB
Hii... Friends, Myself Biswajit Sarangi and I'm from Odisha . I' m a new comer... And I am a student of +3, 2nd year in Economics ...
BRB
Thank you Biswajit
It's okay ... Any other questions ...
BRB
Yes
When investment increases then why mec expected to decrease
as more and more capital is used in the production process, the MEC will fall due to diminishing marginal product of capital.
sagar
I think during the period of inflation.. That's why during this period money supply increases which leads to the fall in rate of interest that tends to rise in AD and Income of the house holders, thus investment increases... Therefore during Inflation Investment increases initially while the MEC...
BRB
understand with this example Subhadra - The more you drink water the less you feel thirsty. Each unit of water quench your thirst by one unit. As a result a time arrives when you are no more thirsty. Similarly, Every business has an optimum level of utilisation of capital. After the optimum level
sagar
the business cannot provide returns to the further unit of capital
sagar
sagar
As soon as MEC is equated to r, no new investment will be made in any income-earning asset.
sagar
r is rate of interest
sagar
Okay. Thank you Sagar Dey
Thanks Biswajit
Glad to know that. Thank you so much. I will try my best to remain here.
sagar
Sir, I wanna know which references are very good to click JRF... I endeavour hard from now to achieve it ... Hence please send me the book lists and I too had a good collection still ...
BRB
please What are forward and backward multipliers?
kouassi
Process of multiplier works in two ways. (1) Forward action of multiplier indicates that as a result of increase in initial investment there is several times more increase in income.
BRB
That means a rise in I ( investment) leads to increase in production which creates Y ( income) and generate consumption expenditure.This process continues till no further rise in income and expenditure is possible.
BRB
Influence of Forward action multiplier is more in those countries where MPS is small while MPC is large .
BRB
(2) Backward action of multiplier denotes as a result of decrease in initial (I) investment there is several times more decrease in the Y. It often called the Reverse action of multiplier.
BRB
Here investment falls, thus both consumption and aggregate Income will be the multiple of initial decline in I .
BRB
Suppose in an economy, I was 10 crore and recently it falls by 3 crore. If the K or multiplier co-efficient is 2, then Y will decrease by 3 × 2 = 6 crore
BRB
Similarly of I rise by 2 crore and the K is 2, then Y will increase by 2 × 2 = 4 crore.
BRB
K means multiplier co-efficient that implies the power by which any initial investment expenditure is multiplied to obtain a final increase or decrease in income. For epitome:- if ∆I = 2, then obviously ∆Y = more than 2, say 10; then K = 5. So, K = ∆Y ÷ ∆I
BRB
I think you can now understand what you want to know, unless ask again...
BRB
yes i've got it now. thank you very much brb biswajit
kouassi
U must welcome Kouassi
BRB
@BRB - there are books published by Arihant for both paper 1 & 2
sagar
No.. No..Sir, I wanna know which books are good to prefer for Micro, Macro, Math, Developmental, International and Indian economics... please send the books name that you prefer to click JRF. And too which university is better for PG
BRB
Please tell me website where I can find out sex ratio, dop, literacy rate etc. Of the state as well as of the country
Wagner's law of economic activities?
Wagner's law An observation made in the 19th century by Adolph Wagner (1835–1917) that the share of the public sector in gross domestic product had increased over time. Wagner's law was the prediction that this trend would continue.
sagar
Okay
@BRB - Delhi School of Economics or JNU. make a watsapp group, I'll share the books
sagar
Cool
Mansi
@subhadra - website of NSSO & CSO
sagar
I read that .. "According to this law there is both an extensive and intensive increase in government activities." please explain it.
Delhi school of economics
Mansi
OK thanks
alayo
Thank you Sagar Dey
I think our messages has been deleted above
@subhadra- Extensive is based on the expansion of the quantity of inputs in order to increase the quantity of outputs. Intensive is the process by which a nation improves the economic, political, and social well-being of its people.
sagar
Word limit is a huge constraint in this application. Watsapp would be a better platform, with multiple options, to conduct a healthy discussion regarding any topic.
sagar
Unfortunately, I can't obtain a sit in both the colleges. I am an arts student and in both the colleges Math is necessary for admission. But I did not take the subject in my +2 . So, I can't. Any other universities if you know where Math is not necessary to get admission as Utkal University or ...
BRB
define absolute and comparative advantage. relate the concept of comparative advantage opportunities for mutually beneficial exchange.
what is it meant by increasing law opportunity cost? what does the law suggest about consumers interest in consuming a good as more and more of it is produced?
Emily
what does the Production Possibilities Frontier (PPF) represent? What does an outward movement of the PPF curve represent? Is it possible to have a level of consumption that exceeds the level of production represented by the PPF? If so, how?
Emily
list and discuss the shift factors for demand. list and discuss the factor for supply.
There are mainly four factors for shift factors for demand. 1) Change in Income level of buyers. 2)Change in consumer taste/preference. 3) Changes in price of related goods. 4) Changes in buyers expectations
Dinosaur
Factors for Supply . 1) Price. 2) Cost of production. 3) Natural Condition. 4) Technology
Dinosaur
thanks.
Emily
💕
my pleasure
Dinosaur