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Aggregate Demand and Aggregate Supply.

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AGGREGATE DEMAND AND AGGREGATE SUPPLY a. What are the determinants of Aggregate Demand and Aggregate Supply? Aggregate Demand: Aggregate demand is the total of all expenditures made within a country at an average price level. There are four main factors that influence the aggregate demand and can cause a shift in an aggregate demand curve. This are: consumer spending, investment expenditure, government spending and net export expenditure. They can be represented through this formula: AD = C+I+G+NX Consumer spending makes up the larges part of aggregate demand, which is between 60% and 70%. These include private spending on: durable goods such as cars and electronic goods, non-durable goods such as provisions, clothes, and literature, and services such as education, insurance, healthcare and entertainment. Consumer spending is strongly influence by the amount of disposable income, household wealth, interest rates and the expected future of the economy. Investment Expenditure makes up a smaller portion of the total aggregate demand. It is easily influence by interest rates which cause higher borrowing costs and thereby lower profit. Government expenditure is affected by the demand of public goods and services by the private sector through voting or other political activities. Net export expenditure is the exports (expenditure of other countries on the country's goods and services) ...read more.


From the short-run aggregate supply curve one can observe that the shift upward indicates the output stays the same while the price increases from P to P1. b. Explain the difference between demand-side and supply-side policies. Demand-side policy: Demand-side policy is used to stabilize the economy by changing the aggregate demand. When there is a lack of demand the aim of the government should be to increase it. The most important demand-side policies are fiscal and monetary. When using fiscal policy the government tries to influence the level of economic activity through controlling government expenditure and taxation. To stop recession and boost the economy, direct and indirect taxes are cut or there is an increase in government spending. This will shift the aggregate demand curve upwards from AD to AD2. In order to reduce the level of demand in the economy and to help reduce inflation, the taxes will rise or government spending will be reduced. Such actions will cause the aggregate demand curve to shift downwards from AD to AD1. Monetary policy is used to control the level of the money supply and interest rates to influence the economic. When the economy is at recession the central bank will increase the economic activity through decreasing reserve requirements, buying government securities or lowering the interest rates, which will shift the aggregate demand curve upwards. ...read more.


Which of the policies above do you consider to be the most useful? Explain your answer fully. Both the supply-side and the demand-side policies are useful; however, they can be used to achieve different effects. The demand side policies work quickly because the increase in money supply is done directly through interest rates, taxation, etc. Within the next 6 month. It is used to deal with short term problems such as inflation or unemployment. Yet, it is very hard to predict an accurate outcome and the situation might go out of control. Supply side policies take much longer time and reduce the pressure on prices and increase employment. They are safer and should cause a gradual improvement in the economy. Demand side policies can be effective when there is little economic activity. But when the economy grows and there is more economic activity demand side policies become less effective because _____________________________________________ ________________________________________________________________________________________________________________________________________________so when the economy is doing well we need the supply side policy. However, demand-side policies often have supply-side effects and vise versa, therefore it is very important to take them in account. Tax decrease may cause less work effort according to the Laffer Curve. At the same time even though supply side policies often increase efficiency they may also cause inequity to raise. Supply-side policies are basically designed to improve economic activity in the long run, while the demand-side policies are used in the short run. ...read more.

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