Aggregate supply and demand - Term Paper Example

? Aggregate Supply and Demand Table of Contents Table of Contents 2 Introduction 3 Answer Resource Allocation 3 Answer 2 5 Answer 3 5 Answer 4 6 Answer 5 7 Answer 6 7 Answer 7 8 References 8 Introduction The resources that the world is endowed with are limited. On the other had human beings have unlimited wants. In a free market economy, the forces of demand and supply determine the market equilibrium and the prices are determined by the price system. When a country or a company has a comparative advantage compared to the other countries, producing a same good, the country which has the advantage can supply the good at a cheaper rate compared to the other countries. As a result the net profit increases. Answer 1: Resource Allocation Resource Allocation is the method in which the limited resources of an economy are distributed among the alternative uses that satisfy the wants of the users. The process of decision making by which it is determined which want is to be fulfilled and which is not is part of the allocation process. Scarcity This concept in economics means that the human needs cannot be completely satisfied because an economy does not have the sufficient resources that can contribute to production. The scarce resources include the factors of production, i.e. land, labor, capital and organization. For example, the amount of land that can be used for productive purposes is limited. This means that land is a scarce resource and the supply is limited (Schiller, 2010). Competitive Advantage A country X has a competitive advantage over another country Y if the country X has abundant resources that are required to produce a good in the country and thereby enjoys a price advantage over the other country. For example, a country may be labor abundant compared to another country that is labor is available at a cheaper rate compared to the first country. Thus it reduces the cost of production for that country. Hence the first country has a competitive advantage over the second country in the supply of labor force. Market System A market system is a set-up in which buyers and sellers interact with one another and trade in a good or service at a price that is determined by the market forces. The number of buyers and sellers can range between one and infinity and the goods can be homogenous or differentiated. Role of Supply and demand The market forces of demand and supply are instrumental in determining the price and quantity at which the trade between the buyers and sellers would take place. The market equilibrium will be achieved at the point where the quantity demanded will be equal to the quantity supplied (Pindyck and Rubinfeld, 2001). In the above figure the downward sloping graph depicts the demand for a good in the economy and the upward rising curve is the supply curve. At the equilibrium point the price at which the good is supplied is P* and the quantity demanded is Q*. Answer 2 The Laissez-faire theory has come from this concept in which there is opportunity for free entry and exit and the government does not impose any restriction on the functioning of the markets. On the other hand in the mixed economy the ownership of the means of production is shared between the government and the private players. In such economies the government has significant control over the economic variables though the capital accumulation is done mainly by the private sector (Conklin, 1991). The socialist economies are almost contradictory to these economic systems. In such a kind of economy the ownership of the factors of production remains with the general public. Such a kind of economic system is a planned one and the decision of allocation of the resources remain with the government. So the demand and supple forces are less significant in case of the socialist economies. Answer 3 If a particular business has abundant resources that it needs for its production them the company would be able to make huge profits compared to the other companies. For example, suppose a company that produces cloth has greater access to cotton plantation then the company will acquire the raw materials at a cheaper rate (Krugman and Obstfeld, 2003). This means that the supply of raw material is more for that company which has provided it with an edge over the other companies. Answer 4 Most of the national economic policies that the government of any state adopts include the fiscal and the monetary policy. The fiscal policy is the process in which the government imposes tax on the residents and adjusts the expenses that the government has in its agenda. On the other hand in case of the monetary policy the government injects liquidity into the economy or takes out the money though expansionary or contractionary monetary policies. The expansionary monetary policies have several short term effects. It leads to a trade of between the inflation and unemployment in the economy (Blanchard, 2000). In case of an expansionary monetary policy, the central bank cuts the interest rates as a result of which the money supply in the economy increases. This is because the people start selling their bonds. As a result the aggregate demand of the economy also increases. This leads to a reduction in the rate of unemployment but increases the inflation in the economy. The above diagram has shown the relation of trade off between aggregate demand and the rates of inflation and unemployment. The right hand panel shows the Philips curve that explains the inverse relation between these two macroeconomic variables. On the other hand the growth rate of the economy would be positively influenced by the aggregate demand of the economy. As the aggregate demand increases the firms will start producing more which in turn would result in the increase in the utilization of the resources. As a result the unemployment would decrease in the economy. Answer 5 Balance of Trade is the difference between the exports and imports of a country. A country would be facing trade deficit if the imports of the country exceeds its exports. On the other hand a country may face a budget deficit if the expenditure of the government is more than the income of the government which is earned mainly through the taxes. The government can influence the balance of trade by adjusting the levels borrowing in the economy, manipulating the tax rates and modifying the spending on various projects. If the country faces at trade deficit the government has to impose restrictions on the outflow of the money through the impositions of quotas and tariffs. Along with that the spending on the domestic projects has to be increased so that the imported goods are produced domestically. Answer 6 Money is a unit of account that has some value and which is paid in exchange of goods and services. Money has different functions. It acts as a medium of exchange in a non-barter economy. It acts as a unit of account. It also has some values and is used as a standard that is essential for making delayed payments. The money supply in a country is provided by the central banks in different ways. First of all the central bank has the right to print notes and it can create money physically. The banks can also buy assets and securities and add to the money supply. Answer 7 The two most popularly discussed schools of economics are the Classical and the Keynesian Schools. The Classical Theory believes in the free market where the role of the government is somewhat insignificant. The firms and the households are the main sources of accumulation of capital according to this theory. The economic theory provided long term solutions to the macroeconomic problems. On the other hand the Keynesian School is of the opinion that the aggregate demand and the aggregate supply are the major tools that control market. Unlike the Classical economists, the Keynesians believe that the government spending is essential to boost the economic activities of a country (Markwell, 2006). References Blanchard, O. (2000). Macroeconomics. Englewood Cliffs: Prentice Hall. Conklin, D.W. (1991). Comparative Economic Systems: Objectives, Decision Modes, and the Process of Choice. Cambridge: Cambridge University Press. Krugman, P. R. and Obstfeld, M. (2003). International Economics: Theory and Policy. Boston: Addison-Wesley. Markwell, D. (2006). John Maynard Keynes and International Relations: Economic Paths to War and Peace. Oxford: Oxford University Press. Pindyck, R and Rubinfeld, D. (2001). Microeconomics. London: Prentice-Hall. Schiller, B. R. (2010). Essentials of Economics. New York: McGraw-Hill Higher Education. Read More