Economics Aggregate Demand And Supply Questions Long
When aggregate demand exceeds aggregate supply, it leads to a situation known as demand-pull inflation. This occurs when the overall demand for goods and services in an economy surpasses the available supply, causing prices to rise. As a result, both the price level and real GDP are affected.
1. Price Level: When aggregate demand exceeds aggregate supply, there is an upward pressure on prices. This is because consumers are willing to pay higher prices to secure the limited supply of goods and services. As a result, the price level increases, leading to inflationary pressures in the economy.
2. Real GDP: In the short run, when aggregate demand exceeds aggregate supply, there is an increase in production and economic activity to meet the higher demand. Firms may increase their output by utilizing existing resources more intensively or by hiring additional workers. This leads to an expansion of real GDP, as the economy operates above its potential output level.
However, in the long run, the situation may change. As prices rise due to excess demand, firms may respond by increasing their prices and adjusting their production levels. This adjustment process is known as the self-correcting mechanism. In the long run, the economy tends to return to its potential output level, and real GDP may not be significantly affected.
It is important to note that the impact on real GDP and the price level may vary depending on the specific circumstances and the time frame considered. Additionally, the government's response to the situation, such as implementing monetary or fiscal policies, can also influence the outcomes.