Question

Write an essay about ''Aggregate Economy'' (min 200 words)

Answer 1

Macroeconomics is a branch of economics that studies how an overall economy—the market systems that operate on a large scale—behaves. Macroeconomics studies economy-wide phenomena such as inflation, price levels, rate of economic growth, national income, gross domestic product (GDP), and changes in unemployment.

Some of the key questions addressed by macroeconomics include: What causes unemployment? What causes inflation? What creates or stimulates economic growth? Macroeconomics attempts to measure how well an economy is performing, to understand what forces drive it, and to project how performance can improve.

Macroeconomics deals with the performance, structure, and behavior of the entire economy, in contrast to microeconomics, which is more focused on the choices made by individual actors in the economy ((like people, households, industries, etc.).

Inflation

Inflation is a quantitative measure of the rate at which the average price level of a basket of selected goods and services in an economy increases over some period of time. It is the rise in the general level of prices where a unit of currency effectively buys less than it did in prior periods. Often expressed as a percentage, inflation thus indicates a decrease in the purchasing power of a nation’s currency.

Inflation can be contrasted with deflation, which occurs when prices instead decline.

As prices rise, a single unit of currency loses value as it buys fewer goods and services. This loss of purchasing power impacts the general cost of living for the common public which ultimately leads to a deceleration in economic growth. The consensus view among economists is that sustained inflation occurs when a nation's money supply growth outpaces economic growth.

Understanding IAggregate IDemand

Aggregate Idemand Irepresents Ithe Itotal Idemand Ifor Igoods Iand Iservices Iat Iany Igiven Iprice Ilevel Iin Ia Igiven Iperiod. IAggregate Idemand Iover Ithe Ilong-term Iequals Igross Idomestic Iproduct I(GDP) Ibecause Ithe Itwo Imetrics Iare Icalculated Iin Ithe Isame Iway. IGDP Irepresents Ithe Itotal Iamount Iof Igoods Iand Iservices Iproduced Iin Ian Ieconomy Iwhile Iaggregate Idemand Iis Ithe Idemand Ior Idesire Ifor Ithose Igoods. IAs Ia Iresult Iof Ithe Isame Icalculation Imethods, Ithe Iaggregate Idemand Iand IGDP Iincrease Ior Idecrease Itogether.

Aggregate Idemand Iconsists Iof Iall Iconsumer Igoods, Icapital Igoods I(factories Iand Iequipment), Iexports, Iimports, Iand Igovernment Ispending Iprograms. IThe Ivariables Iare Iall Iconsidered Iequal Ias Ilong Ias Ithey Itrade Iat Ithe Isame Imarket Ivalue.

To combat this, a country's appropriate monetary authority, like the central bank, then takes the necessary measures to keep inflation within permissible limits and keep the economy running smoothly.

Inflation is measured in a variety of ways depending upon the types of goods and services considered and is the opposite of deflation which indicates a general decline occurring in prices for goods and services when the inflation rate falls below 0%.

Causes of Inflation

Rising prices are the root of inflation, though this can be attributed to different factors. In the context of causes, inflation is classified into three types: Demand-Pull inflation, Cost-Push inflation, and Built-In inflation.

Demand-Pull Effect

Demand-pull inflation occurs when the overall demand for goods and services in an economy increases more rapidly than the economy's production capacity. It creates a demand-supply gap with higher demand and lower supply, which results in higher prices. For instance, when the oil producing nations decide to cut down on oil production, the supply diminishes. It leads to higher demand, which results in price rises and contributes to inflation.

Cost-Push Effect

Cost-push inflation is a result of the increase in the prices of production process inputs. Examples include an increase in labor costs to manufacture a good or offer a service or increase in the cost of raw material. These developments lead to higher cost for the finished product or service and contribute to inflation.

Built-In Inflation

Built-in inflation is the third cause that links to adaptive expectations. As the price of goods and services rises, labor expects and demands more costs/wages to maintain their cost of living. Their increased wages result in higher cost of goods and services, and this wage-price spiral continues as one factor induces the other and vice-versa.

Economic Growth

Economic growth is an increase in the the production of economic goods and services, compared from one period of time to another. It can be measured in nominal or real (adjusted for inflation) terms. Traditionally, aggregate economic growth is measured in terms of gross national product (GNP) or gross domestic product (GDP), although alternative metrics are sometimes used.

In simplest terms, economic growth refers to an increase in aggregate production in an economy. Often, but not necessarily, aggregate gains in production correlate with increased average marginal productivity. That leads to an increase in incomes, inspiring consumers to open up their wallets and buy more, which means a higher material quality of life or standard of living.

In economics, growth is commonly modeled as a function of physical capital, human capital, labor force, and technology. Simply put, increasing the quantity or quality of the working age population, the tools that they have to work with, and the recipes that they have available to combine labor, capital, and raw materials, will lead to increased economic output.

Measured in Dollars, Not Goods and Services

A growing or more productive economy makes more goods and provides more services than before. However, some goods and services are considered more valuable than others. For example, a smartphone is considered more valuable than a pair of socks. Growth has to be measured in the value of goods and services, not only the quantity.

Another problem is not all individuals place the same value on the same goods and services. A heater is more valuable to a resident of Alaska, while an air conditioner is more valuable to a resident of Florida. Some people value steak more than fish, and vice versa. Because value is subjective, measuring for all individuals is very tricky.

The common approximation is to use the current market value. In the United States, this is measured in terms of U.S. dollars and added all together to produce aggregate measures of output including Gross Domestic Product.

Gross Domestic Product (GDP)

Gross domestic product (GDP) is the total monetary or market value of all the finished goods and services produced within a country's borders in a specific time period. As a broad measure of overall domestic production, it functions as a comprehensive scorecard of a given country’s economic health.

Though GDP is typically calculated on an annual basis, it is sometimes calculated on a quarterly basis as well. In the U.S., for example, the government releases an annualized GDP estimate for each fiscal quarter and also for the calendar year. The individual data sets included in this report are given in real terms, so the data is adjusted for price changes and is, therefore, net of inflation. In the U.S., the Bureau of Economic Analysis (BEA) calculates the GDP using data ascertained through surveys of retailers, manufacturers, and builders, and by looking at trade flows.

The calculation of a country's GDP encompasses all private and public consumption, government outlays, investments, additions to private inventories, paid-in construction costs, and the foreign balance of trade. (Exports are added to the value and imports are subtracted).

Of all the components that make up a country's GDP, the foreign balance of trade is especially important. The GDP of a country tends to increase when the total value of goods and services that domestic producers sell to foreign countries exceeds the total value of foreign goods and services that domestic consumers buy. When this situation occurs, a country is said to have a trade surplus. If the opposite situation occurs–if the amount that domestic consumers spend on foreign products is greater than the total sum of what domestic producers are able to sell to foreign consumers–it is called a trade deficit. In this situation, the GDP of a country tends to decrease.

In addition, there are several types of GDP measurements:

• Nominal GDP: GDP evaluated at current market prices
• Real GDP: Real GDP is an inflation-adjusted measure that reflects both the value and the quantity of goods and services produced by an economy in a given year.
• GDP Growth Rate: The GDP growth rate compares one quarter of a country's GDP to the previous quarter in order to measure how fast an economy is growing.
• GDP Per Capita: GDP per capita is a measurement of the GDP per person in a country's population; it is a useful way to compare GDP data between various countries.

Aggregate IDemand ICurve

If Iyou Iwere Ito Irepresent Iaggregate Idemand Igraphically, Ithe Iaggregate Iamount Iof Igoods Iand Iservices Idemanded Iis Irepresented Ion Ithe Ihorizontal IX-axis, Iand Ithe Ioverall Iprice Ilevel Iof Ithe Ientire Ibasket Iof Igoods Iand Iservices Iis Irepresented Ion Ithe Ivertical IY-axis.

The Iaggregate Idemand Icurve, Ilike Imost Itypical Idemand Icurves, Islopes Idownward Ifrom Ileft Ito Iright. IDemand Iincreases Ior Idecreases Ialong Ithe Icurve Ias Iprices Ifor Igoods Iand Iservices Ieither Iincrease Ior Idecrease. IAlso, Ithe Icurve Ican Ishift Idue Ito Ichanges Iin Ithe Imoney Isupply, Ior Iincreases Iand Idecreases Iin Itax Irates.

Calculating IAggregate IDemand

The Iequation Ifor Iaggregate Idemand Iadds Ithe Iamount Iof Iconsumer Ispending, Iprivate Iinvestment, Igovernment Ispending, Iand Ithe Inet Iof Iexports Iand Iimports. IThe Iformula Iis Ishown Ias Ifollows: IAD I= IC I+ II I+ IG I+ INx

Where:

• C I= IConsumer Ispending Ion Igoods Iand Iservices
• I I= IPrivate Iinvestment Iand Icorporate Ispending Ion Inon-final Icapital Igoods I(factories, Iequipment, Ietc.)
• G I= IGovernment Ispending Ion Ipublic Igoods Iand Isocial Iservices I(infrastructure, IMedicare, Ietc.)
• Nx I= INet Iexports I(exports Iminus Iimports)

Factors IThat ICan IAffect IAggregate IDemand

The Ifollowing Iare Isome Iof Ithe Ikey Ieconomic Ifactors Ithat Ican Iaffect Ithe Iaggregate Idemand Iin Ian Ieconomy.

Changes Iin IInterest IRates

Whether Iinterest Irates Iare Irising Ior Ifalling Iwill Iaffect Idecisions Imade Iby Iconsumers Iand Ibusinesses. ILower Iinterest Irates Iwill Ilower Ithe Iborrowing Icosts Ifor Ibig-ticket Iitems Isuch Ias Iappliances, Ivehicles, Iand Ihomes. IAlso, Icompanies Iwill Ibe Iable Ito Iborrow Iat Ilower Irates, Iwhich Itends Ito Ilead Ito Icapital Ispending Iincreases.

Conversely, Ihigher Iinterest Irates Iincrease Ithe Icost Iof Iborrowing Ifor Iconsumers Iand Icompanies. IAs Ia Iresult, Ispending Itends Ito Idecline Ior Igrow Iat Ia Islower Ipace, Idepending Ion Ithe Iextent Iof Ithe Iincrease Iin Irates.

Income Iand IWealth

As Ihousehold Iwealth Iincreases, Iaggregate Idemand Iusually Iincreases Ias Iwell. IConversely, Ia Idecline Iin Iwealth Iusually Ileads Ito Ilower Iaggregate Idemand. IIncreases Iin Ipersonal Isavings Iwill Ialso Ilead Ito Iless Idemand Ifor Igoods, Iwhich Itends Ito Ioccur Iduring Irecessions. IWhen Iconsumers Iare Ifeeling Igood Iabout Ithe Ieconomy, Ithey Itend Ito Ispend Imore Ileading Ito Ia Idecline Iin Isavings.

Changes Iin IInflation IExpectations

Consumers Iwho Ifeel Ithat Iinflation Iwill Iincrease Ior Iprices Iwill Irise, Itend Ito Imake Ipurchases Inow, Iwhich Ileads Ito Irising Iaggregate Idemand. IBut Iif Iconsumers Ibelieve Iprices Iwill Ifall Iin Ithe Ifuture, Iaggregate Idemand Itends Ito Ifall Ias Iwell.

Currency IExchange IRate IChanges

If Ithe Ivalue Iof Ithe IU.S. Idollar Ifalls I(or Irises), Iforeign Igoods Iwill Ibecome Imore I(or Iless Iexpensive). IMeanwhile, Igoods Imanufactured Iin Ithe IU.S. Iwill Ibecome Icheaper I(or Imore Iexpensive) Ifor Iforeign Imarkets. IAggregate Idemand Iwill, Itherefore, Iincrease I(or Idecrease). I

Economic IConditions Iand IAggregate IDemand

Economic Iconditions Ican Iimpact Iaggregate Idemand Iwhether Ithose Iconditions Ioriginated Idomestically Ior Iinternationally. IThe Imortgage Icrisis Iof I2008 Iis Ia Igood Iexample Iof Ia Idecline Iin Iaggregate Idemand Idue Ito Ieconomic Iconditions.

The Ifinancial Icrisis Iin I2008 Iand Ithe IGreat IRecession Ithat Ibegan Iin I2009 Ihad Ia Isevere Iimpact Ion Ibanks Idue Ito Imassive Iamounts Iof Imortgage Iloan Idefaults. IAs Ia Iresult, Ibanks Ireported Iwidespread Ifinancial Ilosses Ileading Ito Ia Icontraction Iin Ilending, Ias Ishown Iin Ithe Igraph Ion Ithe Ileft Ibelow. IAll Igraphs Iand Idata Iwere Ifurnished Iby Ithe IFederal IReserve IMonetary IPolicy IReport Ito ICongress Iof I2011.

With Iless Ilending Iin Ithe Ieconomy, Ibusiness Ispending Iand Iinvestment Ideclined. IFrom Ithe Igraph Ion Ithe Iright, Iwe Ican Isee Ia Isignificant Idrop Iin Ispending Ion Iphysical Istructures Isuch Ias Ifactories Ias Iwell Ias Iequipment Iand Isoftware Ithroughout I2008 Iand I2009.

Limitations Iof IAggregate IDemand

Aggregate Idemand Iis Ihelpful Iin Idetermining Ithe Ioverall Istrength Iof Iconsumers Iand Ibusinesses Iin Ian Ieconomy. ISince Iaggregate Idemand Iis Imeasured Iby Imarket Ivalues, Iit Ionly Irepresents Itotal Ioutput Iat Ia Igiven Iprice Ilevel Iand Idoes Inot Inecessarily Irepresent Iquality Ior Istandard Iof Iliving.

Also, Iaggregate Idemand Imeasures Imany Idifferent Ieconomic Itransactions Ibetween Imillions Iof Iindividuals Iand Ifor Idifferent Ipurposes. IAs Ia Iresult, Iit Ican Ibecome Ichallenging Iwhen Itrying Ito Idetermine Ithe Icausality Iof Idemand Iand Irun Ia Iregression Ianalysis, Iwhich Iis Iused Ito Idetermine Ihow Imany Ivariables Ior Ifactors Iinfluence Idemand Iand Ito Iwhat Iextent.

Aggregate ISupply

Aggregate Isupply, Ialso Iknown Ias Itotal Ioutput, Iis Ithe Itotal Isupply Iof Igoods Iand Iservices Iproduced Iwithin Ian Ieconomy Iat Ia Igiven Ioverall Iprice Iin Ia Igiven Iperiod. IIt Iis Irepresented Iby Ithe Iaggregate Isupply Icurve, Iwhich Idescribes Ithe Irelationship Ibetween Iprice Ilevels Iand Ithe Iquantity Iof Ioutput Ithat Ifirms Iare Iwilling Ito Iprovide. ITypically, Ithere Iis Ia Ipositive Irelationship Ibetween Iaggregate Isupply Iand Ithe Iprice Ilevel.

Rising Iprices Iare Itypically Ian Iindicator Ithat Ibusinesses Ishould Iexpand Iproduction Ito Imeet Ia Ihigher Ilevel Iof Iaggregate Idemand. IWhen Idemand Iincreases Iamid Iconstant Isupply, Iconsumers Icompete Ifor Ithe Igoods Iavailable Iand, Itherefore, Ipay Ihigher Iprices. IThis Idynamic Iinduces Ifirms Ito Iincrease Ioutput Ito Isell Imore Igoods. IThe Iresulting Isupply Iincrease Icauses Iprices Ito Inormalize Iand Ioutput Ito Iremain Ielevated.

Changes Iin IAggregate ISupply

A Ishift Iin Iaggregate Isupply Ican Ibe Iattributed Ito Imany Ivariables, Iincluding Ichanges Iin Ithe Isize Iand Iquality Iof Ilabor, Itechnological Iinnovations, Ian Iincrease Iin Iwages, Ian Iincrease Iin Iproduction Icosts, Ichanges Iin Iproducer Itaxes, Iand Isubsidies Iand Ichanges Iin Iinflation. ISome Iof Ithese Ifactors Ilead Ito Ipositive Ichanges Iin Iaggregate Isupply Iwhile Iothers Icause Iaggregate Isupply Ito Idecline. IFor Iexample, Iincreased Ilabor Iefficiency, Iperhaps Ithrough Ioutsourcing Ior Iautomation, Iraises Isupply Ioutput Iby Idecreasing Ithe Ilabor Icost Iper Iunit Iof Isupply. IBy Icontrast, Iwage Iincreases Iplace Idownward Ipressure Ion Iaggregate Isupply Iby Iincreasing Iproduction Icosts.

Aggregate ISupply IOver Ithe IShort Iand ILong IRun

In Ithe Ishort Irun, Iaggregate Isupply Iresponds Ito Ihigher Idemand I(and Iprices) Iby Iincreasing Ithe Iuse Iof Icurrent Iinputs Iin Ithe Iproduction Iprocess. IIn Ithe Ishort Irun, Ithe Ilevel Iof Icapital Iis Ifixed, Iand Ia Icompany Icannot, Ifor Iexample, Ierect Ia Inew Ifactory Ior Iintroduce Ia Inew Itechnology Ito Iincrease Iproduction Iefficiency. IInstead, Ithe Icompany Iramps Iup Isupply Iby Igetting Imore Iout Iof Iits Iexisting Ifactors Iof Iproduction, Isuch Ias Iassigning Iworkers Imore Ihours Ior Iincreasing Ithe Iuse Iof Iexisting Itechnology.

In Ithe Ilong Irun, Ihowever, Iaggregate Isupply Iis Inot Iaffected Iby Ithe Iprice Ilevel Iand Iis Idriven Ionly Iby Iimprovements Iin Iproductivity Iand Iefficiency. ISuch Iimprovements Iinclude Iincreases Iin Ithe Ilevel Iof Iskill Iand Ieducation Iamong Iworkers, Itechnological Iadvancements, Iand Iincreases Iin Icapital. ICertain Ieconomic Iviewpoints, Isuch Ias Ithe IKeynesian Itheory, Iassert Ithat Ilong-run Iaggregate Isupply Iis Istill Iprice Ielastic Iup Ito Ia Icertain Ipoint. IOnce Ithis Ipoint Iis Ireached, Isupply Ibecomes Iinsensitive Ito Ichanges Iin Iprice.

Example Iof IAggregate ISupply

XYZ ICorporation Iproduces I100,000 Iwidgets Iper Iquarter Iat Ia Itotal Iexpense Iof I$1 Imillion, Ibut Ithe Icost Iof Ia Icritical Icomponent Ithat Iaccounts Ifor I10% Iof Ithat Iexpense Idoubles Iin Iprice Ibecause Iof Ia Ishortage Iof Imaterials Ior Iother Iexternal Ifactors. IIn Ithat Ievent, IXYZ ICorporation Icould Iproduce Ionly I90,909 Iwidgets Iif Iit Iis Istill Ispending I$1 Imillion Ion Iproduction. IThis Ireduction Iwould Irepresent Ia Idecrease Iin Iaggregate Isupply. IIn Ithis Iexample, Ithe Ilower Iaggregate Isupply Icould Ilead Ito Idemand Iexceeding Ioutput. IThat, Icoupled Iwith Ithe Iincrease Iin Iproduction Icosts, Iis Ilikely Ito Ilead Ito Ia Irise Iin Iprice.