Firstly, the ASF (Aggregate Supply of Funding) will remain constant with respect to any interest rate changes therefore we will depict it as a vertical line as shown in the above graph. Suppose that due to certain shocks in the economy, the APE line shifts to the right. The increase in APE will require funding to support it but the ASF will remain unresponsive to the change. As consumers move to gain funding, the lenders will drive up the interest rates. Increase in interest rates will crowd out the demand and the output and price levels will remain unchanged.
What if the amount of gold in an economy increased or decreased. Based on the quantity of gold the ASF line would shift to either left or right. If ASF had a rightward shift than it implies that there will be an excess of funding in the economy. Thus the lenders will be willing to provide their money at lower level of interest rates. This lower level of interest rates will induce the consumers to spend more therefore increasing ADF. Now ADF will cross ASF at a decreased interest rate level and both will exceed the GDP level. Increase in a funded demand will cause the firms to increase their prices. This increase in Price Level brings a fall in ASF which will also decrease APE. Prices will continue to move in upward direction until & unless interest rate, APE & ASF return to their original level.
Prior to the Great Depression of 1929, the classical macroeconomics functioned as it was required. There were no economic slumps and employment and GDP’s were stable throughout the period. The assumption of classical macroeconomists regarding the invisible hand was proved to be almost true. There was no need for government policies or intervention to control the economy and macroeconomics was taking care of itself. Suddenly, the Great Depression of 1929 made its way in the economy and plunged economies in state of chaos. Some faltering economies almost experienced a decline of 30% in their GDP and as much ...
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