Aggregate Supply and Demand Essay -- Economics

Aggregate Supply and Demand The quantity theory can be shown graphically in terms of the aggregate-supply aggregate-demand framework that has become popular in macroeconomic textbooks. Aggregate demand is the amount people will spend, or money multiplied by velocity. If money is 30 and velocity is 7, total spending will be 210. Total spending of 210 can be divided between prices and quantities in a number of ways. If the price level (P) is 1, quantity (Q) will be 210. If P is 2, Q will be 105, if P is 3, Q will be 70, if P is 5, Q will be 42, etc. When graphed with axes of price level and transactions, aggregate demand has the form of a rectangular hyperbola.1 This aggregate-demand curve is shown below as the MV curve. The quantity theory assumes that transactions are determined outside the model by the availability of resources and by technology. Because it assumes there are no adjustment problems, the aggregate supply curve is the vertical line shown in the graph above as the T curve. At each price level the same quantity is available, or price level does not influence quantity supplied. The price level is determined by the intersection of these two curves. If the amount of money increases, the aggregate demand curve shifts to the right. Since transactions are fixed, the end results must be an increase in price level. Notice that aggregate-supply and aggregate-demand curves are describing what happens in the market for goods and services, not in the market for money balances. If there is a disturbance in the money market, that disturbance is transmitted to the goods-and-services market via the aggregate-demand curve. The quantity theory encourages us to see a purchase of goods as a sale of money, and a sale of goods as a purchase of money. Changes in the resource market are transferred to the goods-and-services market via the aggregate supply curve. The quantity theory does not see the market for goods and services as the place disturbances begin. What we see happening in this part of the economy is the result of events in other sectors. Though very simple, this model helps make sense of a number of historical events. For example, U. S. economic growth in the late 19th century, spurred by increases in resources and improving technology, was faster than the growth in money stock. The graph above predicts deflation... ...lry, tableware, and artistic purposes. Their actions will reflect the law of demand: whenever a commodity becomes cheaper, people use more of it. Thus if there is a sudden influx of gold into a country that uses it as money, part of the influx will be diverted to its commodity use, and the effects on the amount of money, and hence on the price level, will be lessened. On the other hand, a sudden decline will also be cushioned, because as the commodity grows more valuable, people will transfer it from its commodity use into a monetary use. If the amount of gold declines and it rises in value, there is an incentive to melt down jewelry, tableware, and artistic objects and use the gold as money. Hence a doubling of gold may not double the amount of money, and cutting the amount of gold by one half may not cut money by one half. Second, if money falls in value, the incentive to produce more of it is cut and if it rises in value, the incentive to produce more of it is raised. If the value of gold increases, more people will try to find it, and if its value declines, fewer people will search for it. The third reason takes us into the realm of international economics. Aggregate Supply and Demand Essay -- Economics Aggregate Supply and Demand The quantity theory can be shown graphically in terms of the aggregate-supply aggregate-demand framework that has become popular in macroeconomic textbooks. Aggregate demand is the amount people will spend, or money multiplied by velocity. If money is 30 and velocity is 7, total spending will be 210. Total spending of 210 can be divided between prices and quantities in a number of ways. If the price level (P) is 1, quantity (Q) will be 210. If P is 2, Q will be 105, if P is 3, Q will be 70, if P is 5, Q will be 42, etc. When graphed with axes of price level and transactions, aggregate demand has the form of a rectangular hyperbola.1 This aggregate-demand curve is shown below as the MV curve. The quantity theory assumes that transactions are determined outside the model by the availability of resources and by technology. Because it assumes there are no adjustment problems, the aggregate supply curve is the vertical line shown in the graph above as the T curve. At each price level the same quantity is available, or price level does not influence quantity supplied. The price level is determined by the intersection of these two curves. If the amount of money increases, the aggregate demand curve shifts to the right. Since transactions are fixed, the end results must be an increase in price level. Notice that aggregate-supply and aggregate-demand curves are describing what happens in the market for goods and services, not in the market for money balances. If there is a disturbance in the money market, that disturbance is transmitted to the goods-and-services market via the aggregate-demand curve. The quantity theory encourages us to see a purchase of goods as a sale of money, and a sale of goods as a purchase of money. Changes in the resource market are transferred to the goods-and-services market via the aggregate supply curve. The quantity theory does not see the market for goods and services as the place disturbances begin. What we see happening in this part of the economy is the result of events in other sectors. Though very simple, this model helps make sense of a number of historical events. For example, U. S. economic growth in the late 19th century, spurred by increases in resources and improving technology, was faster than the growth in money stock. The graph above predicts deflation... ...lry, tableware, and artistic purposes. Their actions will reflect the law of demand: whenever a commodity becomes cheaper, people use more of it. Thus if there is a sudden influx of gold into a country that uses it as money, part of the influx will be diverted to its commodity use, and the effects on the amount of money, and hence on the price level, will be lessened. On the other hand, a sudden decline will also be cushioned, because as the commodity grows more valuable, people will transfer it from its commodity use into a monetary use. If the amount of gold declines and it rises in value, there is an incentive to melt down jewelry, tableware, and artistic objects and use the gold as money. Hence a doubling of gold may not double the amount of money, and cutting the amount of gold by one half may not cut money by one half. Second, if money falls in value, the incentive to produce more of it is cut and if it rises in value, the incentive to produce more of it is raised. If the value of gold increases, more people will try to find it, and if its value declines, fewer people will search for it. The third reason takes us into the realm of international economics.