Aggregate Supply Analysis: Political Economy

Solution:

Aggregate expenditure can be defined as the summation of the net export, government purchases, investments, consumptions and other similar things. The aggregate expenditure can be represented with the help of the following equation:

AE = C + I + G + NX

Among these compo

C = Co + MPC ( Yd )

Here C denotes the total amount of consumption, Co represents the autonomous consumption and in this case, the amount of this component is generally independent of the incomes that are disposable (Stafffullcoll.edu, 2016). Here, MPC denotes the marginal propensity to consume. It is a fraction and the value of this fraction ranges from 0 to 1. MPC can be expressed with the help of the following equation:

MPC = change in C / Change in Yd

Here Yd is the disposable income

There is a similar concept like MPC and this concept is known as MPS and this term represents marginal propensity to save. It can be expressed with the help of the following equation:

MPS = change in S / change in Yd

The relation between MPC and MPS can be represented with the help of the following equation:

MPC + MPS = 1

The mean propensity to consume ( APC ) can be expressed with the following equation:

APC = C / Yd

The mean propensity to save ( APS ) can be expressed with the help of the following equation:

APS = S / Yd

The relation between APC and APS can be written with the help of the following equation:

APC + APS = 1.

Economic Equilibrium:

An economy can be said in equilibrium if and only if the aggregate expenditure remains equal to the production or the aggregate supply. Generally the economy constantly shifts between the supply and demand (Alberto, 2011). As a result of this it can be said that the economy is constantly moving towards equilibrium between the aggregate supply and aggregate demand.

From the article, explain the circumstances that would need to occur which would prompt the Reserve Bank to lower interest rates; and use both theAggregate Expendituremodel and also the static Aggregate Demand-Aggregate Supply model to show the impact on equilibrium output and employment if such actions were undertaken by the Reserve Bank. 

Solution:

Aggregate demand: aggregate demand can be defined as the over - all quantity ( desired ) of services and goods which are bought by the government, private investors, households and foreigners (Dutt, 2002). Here all the other things except these are considered to be constants. Hence it can be said that the aggregate demand is the entire output that is demanded at different price levels and like any other demand function it is also represented with a curve. The aggregate demand function possesses four components and these four components are known as net exports, government purchases of services and goods, demand in the private investment, and demand in consumption. The following figure represents the aggregate demand curve.

Aggregate supply:

the aggregate supply can be defined as the total number of outputs of services or goods which a firm desires to manufacture or produce at each and every level ( that are possible) .therefore the aggregate demand and aggregate supply are two different aspects, aggregate demand is not an aggregate quantity, but the aggregate supply is an aggregate quantity (Dutt, 2002). The aggregate supply can also be represented with the help of a curve. According to the classical theory, the nature of the aggregate supply curve is found to be perfectly inelastic and it is found to be a vertical straight line (Singh, 2013). The following diagram represents the aggregate supply curve:

The aggregate supply is two types, one is known as the short – run aggregate supply and the other is known as the long - run aggregate supply. Generally the aggregate supply curve has three distinct ranges and these three distinct ranges are known as the horizontal range, the highly steep range and the intermediate upward – sloping range (Dutt, 2006). The following figure represents all of these three ranges:

The long – run aggregate supply also has three different factors and these three factors are known as the state of the technology, capital stock and the amount of the labour that are available. Generally these are written with the help of the following expression (Singh, 2013):

Y = F ( L, K, T )

The AD - AS model is a macro – economic theory.

3 (a). Given the following statement from the article “Malcolm Turnbull has made raising Australia’s growth rate the central focus of the budget, which is expected to include both fresh infrastructure spending and corporate tax incentives…”, use the dynamic Aggregate Demand-Aggregate Supply (AD-AS) model to explain the hoped for intentions of adopting such an approach on economic output and employment in the long run.

Solution:

The dynamic model of AD – AS i.e. aggregate demand and aggregate supply provides the nature of the economy in more detail. This model is generated from the curves like IS curve and Philips curve. This model helps to keep the track of the time. This can be explained with the help of the following expression (Singh, 2013):

If t is considered as the time period, then

Yt = real Gross Domestic Products ( GDP ) in t period

Y ( t – 1 ) = real Gross Domestic Products ( GDP ) in ( t – 1 ) period

Y ( t + 1 ) = real Gross Domestic Products ( GDP ) in ( t + 1 ) period

This model has five variable and five equations. The five variable are known as expected inflation, rate of interest ( both nominal as well as real ), inflation and output.

Here, Malcolm has focussed only on rising the growth rate of Australia, as a result of this focus, the Gross Domestic Product ( GDP ) will definitely increase the economy of the Australia can be enhanced. 

3(b). With reference to question 3(a) above, and to the uncertainty surrounding “..whether demand will be strong enough to keep unemployment from rising over the year ahead…”, use the dynamic AD-AS model to outline the medium term impact on equilibrium output and employment if such uncertainty turns out to be correct.

Figure 5

From the dynamic AD –AS ( aggregate demand – aggregate supply ) model, it can be understood that if demand increases, it will definitely result into unemployment (Hubbard, 2009).

References

Alberto, C. (2011). Aggregate Demand Aggregate Supply.

Dutt, A. (2002). Aggregate Demand-Aggregate Supply Analysis: A History. History of Political Economy, 34(2), pp.321-364.

Dutt, A. (2006). Aggregate Demand, Aggregate Supply and Economic Growth. International Review of Applied Economics, 20(3), pp.319-336.

Hubbard, R. (2009). Macro economics. Frenchs Forest, N.S.W.: Pearson Prentice Hall.

Singh, S. (2013). Macro economics. New Delhi: APH Pub. Corp.

Stafffullcoll.edu. (2016). Aggregate Expenditure Model. [online] Available at: https://staffwww.fullcoll.edu/fchan/macro/3AE%20MODEL.htm [Accessed 1 Aug. 2016].