Question

"In an economy, Aggregate Demand (AD) is more than Aggregate Supply (AS)." Elaborate the possible impacts of the same, on the level of output, income and employment.

Hint:

When aggregate demand exceeds aggregate supply, the immediate effects are higher output and employment, but inflationary pressures may follow.

Answer 1

When aggregate demand (AD) exceeds aggregate supply (AS), the following impacts can occur:
1. Increased output and income: 
Firms will try to meet the excess demand by increasing production, which will lead to higher output and income levels. 
The increase in income leads to higher consumption, further boosting demand, creating a cycle of growth. 
2. Higher employment: 
Increased production requires more labor, which will lead to higher employment levels. As firms expand output to meet demand, they will need to hire additional workers.
3. Price inflation: 
As AD exceeds AS, firms may raise prices due to higher demand. This can lead to inflationary pressures in the economy.
4. Potential overuse of resources: 
If AD continues to outstrip AS for a prolonged period, the economy may face resource shortages, leading to inefficiencies and higher costs in the long run. 
Conclusion: When AD exceeds AS, the economy initially experiences higher output, income, and employment, but sustained imbalances may lead to inflationary pressures.