Question

“In an economy, ex-ante Aggregate Supply is less than ex-ante Aggregate Demand.” Explain its impact on the level of output, income, and employment.

Hint:

In macroeconomics, an excess of Aggregate Demand over Aggregate Supply leads to economic expansion, while an excess of Aggregate Supply over Aggregate Demand may result in economic contraction.

Answer 1

Understanding the Concept: Ex-ante Aggregate Supply (AS) refers to the planned level of output that producers intend to supply at different price levels, while ex-ante Aggregate Demand (AD) refers to the total planned spending on goods and services in an economy. When ex-ante AS is less than ex-ante AD, it means that the economy's total planned production is insufficient to meet the total planned demand. Impact on Output, Income, and Employment:
1. Impact on Output:
- Since demand exceeds supply, firms experience unplanned inventory depletion.
- To meet the excess demand, firms increase their production.
- This leads to an overall increase in output.
2. Impact on Income:
- As firms increase production, they require more factors of production, such as labor and raw materials.
- This leads to higher payments to workers and suppliers, resulting in an increase in national income.
3. Impact on Employment:
- Higher production levels encourage firms to hire more workers.
- This leads to a reduction in unemployment and an increase in overall employment levels.
Conclusion: When ex-ante AS is less than ex-ante AD, the economy experiences an expansionary phase characterized by rising output, increasing income, and higher employment levels. However, if the excess demand persists for too long, it may lead to inflationary pressures.