Factors That Effect Aggregate Supply And Aggregate Demand

Published Date: 02 Nov 2017

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Q No 1.

Market mechanism

"The process by which a market can solve the problem of allocating all the existing resources, especially that of deciding how much of a good or service should be produced, but other such problems as well. The market mechanism is an alternative, for example, letting the government make such decisions."

Source: University of Michigan, Deardoff’s Glossary of International Economics

Types of markets:

Following are the four main types of markets:

1.    Monopoly

2.   Oligopoly

3.    Monopolistic competition

4.   Perfect competition

Monopoly:

A monopolistic market is a market that features only one, if not every single one, of the characteristics of a monopoly for instance high price levels, supply constraints, or various barriers to entry. Because in a market like this comprises of individual supplier, consumers would have no choice other than to buy only from this individual supplier. Without suitable legislation or controls or rules, this individual supplier has the power to raise prices without unfavorably affecting demand for its products or services. This specific type of market can be in a contrast with a perfectly competitive market. (www.investopedia.com). For example Etisalat formed a monopolistic telecommunication market. In this monopolistic scenario the demand remains the same with the increase in price.

Oligopoly:

An oligopoly is a market structure in which a small number of firms dominate. When a market is shared among a few firms, it is said to be highly concentrated. Even though just some of the firms dominate, it may be possible that many of the small firms may also work in the market. For example, most important airlines like British Airways and Air France operate their routes with just a few close competitors, but there are also many small airlines are giving services for the holidaymaker or offering specialist services for its clients. (www.economicsonline.co.uk).

Monopolistic competition:

This kind of market refers to a market scenario with a relatively outsized number of sellers selling alike but not identical products. Following are some of the characteristics of a monopolistic competition market:

a. Every firm has a small percentage of the present total market.

b. Collusion is almost impossible with so many other firms.

c. Firms proceed independently with no feeling of mutual interdependence between the sellers. The actions of one rival are not noticed by the rest. ( The American School of Guatemala, 2012)

Perfect competition:

A scenario where there are many firms competing in the market, there is lot of competition and the firm producing the best quality goods and services at lowest price can be successful. (Marshall). Following are some of the main charateristics of a perfect competitive market 1. numerous sellers and buyers 2. Homogeneous products avaiable 3. Absence of government intervention in markets 4. Almost perfect information available of the market etc. (Salter, 2009). The Panzar–Rosse H-statistics shows that banks presently operational in Kuwait, Saudi Arabia and the UAE function under perfect competition whereas banks in Bahrain and Qatar exercise under conditions of monopolistic competition. (Saeed Al-Muharrami, 2006)

Q No 2.

Aggregate supply is the total supply of goods and services that a firm in a national economy plan on selling during a particular time period. It is the total amount of goods and services that firm is willing to sell at a stated price level in an economy. For example supply of Honda cars. The firm plans to sell the cars according to a given price level in the UAE economy. However the aggregate supply curve is defined in expressions of the price level. Increase in the price level increases the price that Honda can get for its products, therefore, make more cars. However, an increase in the price would also have another effect; it would also ultimately lead to increase in input prices, which hold other things constant would cause Honda to cut back. So, there is a little uncertainty as to whether the economy will supply more real Gross Domestic Product as the price level rises or not. (SparkNotes Editors). The total sum of goods and services demanded in an economy at a given overall price level and in a given time period is aggregate demand. It is represented by the aggregate-demand curve, which illustrates the relationship between price levels and the quantity of output that firm is willing to give away. Normally there is a negative relationship between aggregate demand and the price level. Also called as the "total spending". (Invetopedia US Inc.). Similarly the demand and supply for individual goods and services, the aggregate demand and aggregate supply for a paticular economy can be signified by a schedule or a curve. The aggregate demand curve represents the total quantity of all goods and services demanded by an economy at different price levels. (diffsnote). An example of an aggregate demand curve below

http://media.wiley.com/Lux/43/9643.nfg001.jpg

The vertical axis shows the price level of all final products and services. The aggregate price level is measured by either the GDP deflator or the CPI. The horizontal axis shows the actual quantity of all the goods and services purchased as measured by the level of real Gross Domestic Product. Notice that the aggregate demand curve like the demand curves for individual goods, is downward sloping, means that there is an inverse relationship between the price level and the quantity demanded of real Gross Domestic Product.

The demand curve for an individual product is drawn under the assumption that the prices of other products remain constant and the assumption that buyers' incomes remain constant too. As the price of cars rises, the demand for cars falls because the relative price of other products is lower and because buyers' real incomes is reduced if they purchase cars at the higher price. The aggregate demand curve, however, is characterized in terms of the price level. A change in the price level entails that many prices change, including the wages that are paid to workers. As wages change, so do incomes. Therefore, it is impossible to assume that prices and incomes remain constant in the structuring of the aggregate demand curve. Hence, one is unable to explain the downward slope of the aggregate demand curve using the same reasoning given for the downward-sloping individual product demand curves.

Q No 3.

Factors that Effect Aggregate Supply and Aggregate Demand

Factors that Effect Aggregate Supply and Aggregate Demand

Aggregate Demand

Aggregate Supply

1. Income

(+)

1. Costs

(a) Labor (wages)

(b) Resource

(–)

2. Wealth

(+)

2. Investment (prior)

(+)

3. Population

(+)

3. Productivity

(+)

4. Interest rates

(–)

4. Interest rates

(+)

5. Credit availability

(+)

5. Credit availability

(+)

6. Government demand

(+)

6. Foreign supply

(–)

7. Foreign demand

(+)

7. Taxation

(–)

8. Taxation

(-)

9. Investment

(+)

10. Expectations

(+)

(+):The increase in this factor causes the curve to shift right.

(–): The increase in this factor causes the curve to shift left.

The changes in equilibrium in the Aggregate Supply and Aggregate Demand model happen due to changes in the variables that effect supply and demand. The variables that are probable to affect supply or demand are listed above. The signs + or - shows some of the assumed direction of control. The relationship between Aggregate Supply, Aggregate Demand and price are represented by the slope of the Aggregate Supply and Aggregate Demand curves; which changes in all other variables cause the curves to shift right or to left.