How equilibrium occurs using the aggregate supply (AS) and aggregate Essay

How equilibrium occurs using the aggregate supply (AS) and aggregate demand (AD) framework - Essay Example This paper describes the occurrence of the equilibrium using aggregate supply and aggregate demand curves, and the fluctuation of real GDP around the potential GDP with reference to the economy in UK. Aggregate Demand Aggregate demand curve represents the desired spending, consumer behaviour and the buying of equipment by governments and foreigners. The aggregate demand rises with the increase in expenditure caused by increased optimism by the households on lifetime incomes and increased need for the product. The combined monetary assets and the decrease in interest rates stimulate the desire to spend by the firms and households. Low interest rates reduce the saving reward and borrowing costs for households, but for businesses, this reduces the borrowing costs for investing in equipment and plant (James, Walte and James 2006, p. 777-790). The aggregate demand curve slopes downwards due to the fixed nominal value for some assets, particularly the money itself. The increase in prices f or the goods with no changes in money leads to the real value of money balances declining and this result to decreased liquidity. The rise in prices increases the demand for dollars in financing the transactions. Short liquidity to the monetary assets results when nominal dollars’ supply does not change. ... Prices and output are inversely related. Shifts in aggregate demand curve Aggregate demand curve changes due to wealth effects like the money supply, interest rate effects, and the net exports effects. The changes are represented by shifts in aggregate demand curves either to the right, or to the left. A right shift in aggregate demand curve (AD1 to AD2) indicates an increase in GDP at the same price level for the quantity demanded. A left shift (AD1 to AD3) indicates a decreased GDP for the quantity demanded at the same price levels (Justiniano & Claudio 2011, p. 89). Shifts in aggregate demand curve Source:http://www.cliffsnotes.com/study_guide/Aggregate-Demand-AD-Curve.topicArticleId-9789,articleId-9737.html Aggregate Supply Aggregate Supply (AS) model measures volume of the goods and services produced by an economy at given overall price level. The AS curve summarizes the production behaviour for the side markets, and it slopes upwards. The Aggregate Supply curve may be horizonta l or vertical depending on the conditions (James, Walte and James 2006, p. 777-790). The curve is inelastic in the long run and elastic in the short run. Therefore, when the long-run curve is vertical, the return is to natural output level as the equilibrating forces pull back to vertical long-run curve. The upward facing slope is caused by changes in firm prices due to the increased demand. In the presence of menu costs, firms raise the prices or increase the production, resulting to aggregate increase in both output and prices (Berrah and Cliville 2007, p.709-719). Graph 2: Aggregate Supply Curve Source: http://www.cliffsnotes.com/study_guide/Aggregate-Supply-AS-Curve.topicArticleId-9789,articleId-9738.html The vertical axis in aggregate supply curve represents the