Aggregate demand is the total sum of goods and services in an economy within a given time and price. Aggregate supply is the total sum of goods and services supplied during a specific time in an economy. When aggregate supply equals aggregate demand, then the result is termed as equilibrium in macroeconomic models. Does this situation always occur?
Aggregate Supply/Aggregate Demand Model
The Aggregate Supply / Aggregate Demand (AD / AS) model is useful for assessing the conditions and factors affecting the Real Domestic Product (GDP) and inflation levels. The factors affecting aggregate demand include level of income, wealth, population, interest rates, credit availability, government demand, taxation, investments, etc. Those that affect aggregate supply are costs, labour wages, recourses available, productivity, and expectations like profits, inflationary and interest rates. According to Keynesian economics, not all GDP investment sums as part of aggregate and demand thus there would be reduced national output and income when there is unplanned investment.
Production process sometimes produces excess goods that result in reduction in prices or demand. So when aggregate expenditures are not equal to aggregate production, this results in changes in prices. This situation is where buyers and the sellers are out of balance. The household, government are unable to purchase all the real production that the producers have and are unable to sell. Disequilibrium simply means an imbalance between total demand and total supply in production. Equilibrium aggregate market is the state where the real aggregate expenditures are equal to real production. This implies that real expenditures and or production do not change, i.e., the opposing forces of aggregate demand and aggregate supply is in balance.
The aggregate supply curve does not usually change independently as the aggregate demand curve does. The aggregate supply curve equation does not contain factors that are directly related the price level or level of output. The aggregate supply curve contains only factors derived from the AD/AS model.
Shifts in the Aggregate Demand Curves
If the demand curve moves towards the left, the total sum of quantity of goods and services needed at any given price levels falls, this is termed as the economy contracting. Consumption and investments lead to a shift to the left. The changes include increases in taxes, making consumption to decrease, or an increase in the savings rate would also have the same effect. Economic expansionary policy changes the aggregate demand curve to the right while economic diminishing policy shifts the aggregate demand curve to the left. Short period total supply movements to the left only affect change in total demand and a change of the price level. The convergent point where the immediate grand supply curve and the total demand curve meet is always the new equilibrium. Thus, expansionist policies causes output and the price level to increase in the short run, but only the price level to move upwards in the long run. The opposite case is found when the aggregate demand curve shifts to the left. When demand changes, the economy always moves from the long-term equilibrium to the short-term equilibrium, and then back to a new long-term equilibrium position (Palley, 1997).
Changes in the supply curve are few, unless in response to the aggregate demand curve. Sometimes a supply shock can occur, e.g., Increases in oil prices, drought, union strikes, etc where the short run supply curve shifts without prompting from the demand side, thus changing the price level of a given amount of output. A positive supply shock causes the price for a given amount of output to reduce. This is represented by the movement of the absolute movement of the supply curve to the right.
Disequilibria Between Aggregate Supply and Aggregate Demand
There are varied factors that cause the condition of disequilibria. These include consumer nominal wealth increases, technology and education increase, planned investment spending, business profit expectations decrease, employee wages increase, etc. Others could be government purchases increase, temporary increases in oil prices, labour endowment increases, permanent increase in business regulations, national income abroad increases, net export spending decreases, prices of raw materials temporarily increases, as well as personal taxes increase (Palley, 1997).
There are many different kinds of buyers, that both rich and poor who want consumer goods and the private companies who want investment goods. Therefore, private households spend their wages on consumer goods. Households may not buy all of the commodities that have been produced, but the workers cannot afford. There is a possibility that investment demand will be high enough to compensate for the insufficient level of workers plus capitalist demands for consumer goods. There are so many times of economic upswing where capitalists expect aggregate demand to rise and ensure they enjoy the demand. They may opt to increase production by expanding investments. If they realize that the demand is not high enough for consumer goods, they will cut back their investment plans. Thus will to lower prices will not bring aggregate demand level up to the level of aggregate supply. Capitalists will still need to have total profits and turnover to remain constant, which will make disequilibria persist. In a competitive economy, some companies will lower their prices and other will not. Those who lower the prices will enjoy a larger share of aggregate demand, which may force the other firms also to cut prices which eventually does not solve the problem of over production. Again, firms with lower productivity will have higher costs, and hence lower profits. On the contrary, productive firms may lower prices and concede some of their profit which may lead to bankruptcy the firms that cannot lower their prices. This causes a condition known as decentralization of capital (Palley, 1997).
High end, high cost technology can only be afforded by large corporations help them increase production and continually give them a higher share of economic activity at the expense of the smaller firms. This leads to a condition known as monopoly capitalism that leads to poor people to struggle to make ends meet. Under consumption harms both rich and poor, as large companies do not make as much money when their products are not needed, and poor people don’t have money to spend and the rich do not spend all the money they have.
Neoclassical and Capitalist Economic Theories
Neoclassical economics is an ideology and not a science, Capitalists’ economies are expansionary by their nature, that every aspect of life must be subjected to the rule of the market. The capitalist will do anything that will drive profits and that is why the poor will get poorer and the rich richer.
According to Dutt, & Skott, (2005), capitalism seeks out those who love it and neoclassical economist love capitalism. Corporations, media, think tanks, governments, and international financial institutions hire capitalist because they cannot go against their own believes. Feudal economies that preceded capitalism had people with fixed and hereditary roles to play while in capitalism making money is the way of life.
Capitalist will even employ children provided they are cheap and considers humans as commodities. It creates a universal class of persons and this was one of the reasons for the French Revolution. The cardinal need of the capitalist is the accumulation of capital and a surplus extracted from the workers by their employers confirms exploitation. This economy would need a surplus production over consumption in terms of money and total revenue generated in production would be greater than the wages paid to the workers. This is because new machinery and equipment wear out and have to be replaced. On the contrary, new equipment and machinery have to be built for the economy to grow, and money must be available to fund consumption like schools, health care, roads, public transportation, etc. Many social scientists today believe that capitalism is gradually transcending government, i.e., Governments no longer control and regulate capital accumulation (Samuelson, &. Nordhaus, 1985).
Governments are also necessary for the production of certain outputs essential for the capitalist production but the markets themselves will not cause to be produced. This is because, not a single capitalist will be sure to reap all the benefits of particular investment, e.g., Like state providing national defence, building roads, bridges, lighthouses, port facilities, airports, railroads, and general education for the work force. Marx argued that continued development of capitalism would only sharpen and increase the misery of workers, but on the contrary, purchasing power of workers has increased since Marx death. Though, he insisted that capitalism systematically prevented individuals from realizing their full potential. The labour time spent in production would not create a commodity with an exchange value equal to the labour time put into it, i.e., producing commodities that have no demand and they would only permit to produce only commodities that at least realize their cost of production. Market demand would determine not only what commodities were produced but also the relative quantities in which they were produced.
Samuelson, & Nordhaus, (1985), surplus value originated from the fact that capitalists bought one commodity and sold a different one. Profits were realized in the senses that labour power was less than the value of the commodities produced with the labour power. Just like with every other commodity, the labour time necessary for its maintenance and reproduction implied that the value of the subsistence necessary for the maintenance of the labourer at a socially defined standard of living. The average working day of a labourer exceeded the time necessary for a labourer to produce the value equivalent of his subsistence wage, which enabled the capitalist to appropriate the surplus produced over and above his subsistence.
Concentration of wealth and economic power in the hands of a few capitalists results into competition amongst themselves. This created a situation where the strong either crushed or absorbed the weak. As technology improved, there was an increase in the minimum amount of capital necessary to carry on with business. Thus to remain competitive, an organisation has to increase the capacity and productivity of its workers. This creates a scenario where changing technology, as well as competition amongst capitalists moves capital to fewer capitalists widening the gap with the majority of the society (Samuelson, & Nordhaus, 1985).
- Samuelson, P, &. Nordhaus D, (1985). Economics. 12th ed. NewYork: McGraw Hill.
- Dutt, K. & Skott, P. (2005). “Keynesian Theory and the AD-AS Framework: A reconsideration,” Working Papers 2005-11, University of Massachusetts Amherst, Department of Economics.
- Palley, T. (1997). “Keynesian theory and AS/AD analysis“. Eastern Economic Journal, Fall.