Question

"In an economy, Aggregate Demand (AD) is more than Aggregate Supply (AS)." Elaborate the possible impacts of the same, on the level of output, income and employment.

Hint:

When aggregate demand exceeds aggregate supply, the immediate effects are higher output and employment, but inflationary pressures may follow.

Answer 1

When aggregate demand (AD) exceeds aggregate supply (AS), the following impacts can occur:
1. Increased output and income: 
- Firms will try to meet the excess demand by increasing production, which will lead to higher output and income levels. 
- The increase in income leads to higher consumption, further boosting demand, creating a cycle of growth. 
2. Higher employment: 
- Increased production requires more labor, which will lead to higher employment levels. - As firms expand output to meet demand, they will need to hire additional workers.
3. Price inflation: 
- As AD exceeds AS, firms may raise prices due to higher demand. This can lead to inflationary pressures in the economy.
4. Potential overuse of resources: 
- If AD continues to outstrip AS for a prolonged period, the economy may face resource shortages, leading to inefficiencies and higher costs in the long run. 
Conclusion: When AD exceeds AS, the economy initially experiences higher output, income, and employment, but sustained imbalances may lead to inflationary pressures.