What is Aggregate Demand? What is Aggregate Demand? Discuss the effects of a shift in Aggregate Demand on equilibrium.

 Aggregate Demand 

Aggregate Demand is the amount of goods and services that all consumers are willing to buy, the amount of investment that organizations are willing to buy, the amount of goods and services that the government is willing to buy and the net exports that foreigners have to buy. The outcome of all this is based on the decisions made by all consumers, institutions, governments and foreigners. In other words, the overall demand is the amount of goods and services that different individuals, firms and governments at different levels are willing to purchase. That is, the overall demand line (AD) reveals the relationship between output and price level as shown in the figure. 

Overall demand

 Aggregate demand line The aggregate demand line indicates the amount of demand for all goods and services in an economy at different levels. That is to say, the aggregate demand line is a line at the point where the product or actual income and the various levels of the price level are expressed. As can be seen in the figure, the overall demand line is going down from left to right. This implies that when other conditions remain unchanged, the overall demand for goods or services increases when the price level decreases and the overall demand for goods or services decreases when the price level increases. The figure shows that if the price level decreases from P1 to P2, the production or real income increases from Y1 to Y2 and if the price level increases from P1 to Po, the production or actual income decreases from Y1 to Yo.

The effects of a shift in Aggregate Demand on equilibrium 

The initial equilibrium point in the figure is A. Suppose, for some reason, the overall demand in the economy declined. The overall demand line shifted from AD1 to AD2. As a result the economy moved from point A to point B on the SRAS1 line in a short time. This resulted in a decrease in production from Y1 to Y2 and lower levels from P1 to P2. 

Impact on overall demand line shift balance

 The effect on the balance of contraction in aggregate demand indicates a recession of the economy. In this case, the firms will gradually reduce the investment. That is, the recession indicates a long-term decline in production and an increase in unemployment. What can policy makers do to overcome the recession? One way is to increase the overall demand. We have seen the reasons why the overall demand increases. By increasing the overall demand, policy makers can bring the overall demand line back from AD, to AD1. As a result, the economy is again balanced at point A. 

What can happen if the recession passes over time without any action by the policy makers? As the overall demand and the expectation of lowering the price level also adjusts to the new change and the expected price level decreases, the expected lower level changes the perception of labor wages, prices and future, shifting the SRAS line to the right SRAS1. This condition is shown by the point C in the figure. Where the AD line crosses the LRAS line. In the long-term macroeconomic equilibrium, the economy reaches the expected production level at point C, where the decline in overall demand ranges from P1 to P3; This reduces. 

That is, in the long run the change in overall demand is reflected by the change in the price level and not by the change in the level of production.

 So, 

There are two important aspects to the change in overall demand - 

In the short run, shifting the overall demand line leads to a decrease-increase in the production of goods or services in the economy. 

In the long run, the change in overall demand affects the price as a whole, not the level of production.