Aggregate demand and aggregate supply

Economists explain changes in a nation's total output, employment, and price level with the model of aggregate demand and aggregate supply. Aggregate demand is the total spending on an economy's goods and services by households (consumption), businesses (investment), government, and buyers abroad (net exports). Aggregate supply is the total output firms are willing to produce at each price level; in the short run it rises with the price level, while in the long run it is tied to the economy's productive capacity, its potential output. When aggregate demand falls, for example because consumers and businesses lose confidence, output drops and unemployment rises, as in a recession. When aggregate demand grows faster than the economy can produce, prices rise, causing inflation. A negative supply shock, like a sudden jump in oil prices, can cause stagflation, rising prices together with falling output, as in the 1970s. The multiplier effect means an initial change in spending can change total output by more than the original amount, because one person's spending becomes another person's income. Fiscal and monetary policy work mainly by shifting aggregate demand.

This explanation is AI-generated and can occasionally be wrong. 🚩 Report