Crucial Target of Stability and Equilibrium

Question: Discuss about the Crucial Target of Stability and Equilibrium. Answer: Introduction: The crucial target of any economy is to maintain stability and equilibrium in the nation. Economics deals with this equilibrium, which can be defined as the ways in which the economic forces are balanced within the nation by the interaction of the two factors, the demand and the supply (Mankiw, 2014). The state of equilibrium is such that at that point none of the agents are willing to deviate from their situation unless some distortion in the market takes place as that may hamper their utility. In this write-up the interaction of the aggregate demand and the aggregate supply theory has been used to interpret the stability of the market. The concept of both the short run and the long run aggregate supply has been used to illustrate the reason behind the economy not deviating from the equilibrium in the long-run. Analysis and Discussion: The term aggregate demand can be described as the total quantity of goods and services that the consumers may demand at every possible range of prices (Michaillat Saez, 2013). Like any other demand curve the AD is also downward sloping which implies that consumers wants more goods a lower prices and vice-versa. At any point on the AD curve there is a match between the actual expenditure and planned expenditure of the consumers. The aggregate supply on other hand indicates the total production of the economy at every possible price ranges. The total quantity of services and goods produced in the market over a certain period of time indicates the aggregate supply of the economy. The AS curve is upward sloping as producers feel it fruitful to produce more goods at higher prices and less amount of goods when prices offered to them are less (Canto, Joines, Laffer, 2014). The economy can be divided into three types of market namely the labor market, the financial market and product market. Amalgamation of the three markets leads to the global equilibrium where the financial market acts as an intermediary between the two other markets. The AD curve has been generated from the IS-LM model and the AD-AS model helps us in understanding the short-run fluctuations in the economy (Bernanke, Antonovics, Frank, 2015). The diagram below highlights the short run scenario of the economy. The figure above highlights the equilibrium scenario of the market. At the initial level the equilibrium was at point E1 with the price at P1 and quantity at Y1. If there is a sudden rise in the output level then the short-run supply curve shifts outward. Also if there is a sudden decline in the price of the components that reduces the total production cost then there can be a possibility of change in the supply curve. Due to this shift in the SRAS curve, the equilibrium is distorted and the price decreases to point P2 from P1. At the same time the output produced increases to Y2 from Y1. Keeping other thing constant, the resultant effect is the change in the short run level of equilibrium in the economy. In the short run, at least one of the factors used in the production are fixed in nature and hence the economy may or may not be able to gain back the stability lost in the market. The government intervenes in the short run to restore the lost equilibrium by taking up either the expansionary or contractionary fiscal policy (Schwieelmann, 2013). If the government wants to reduce the output in the market then it takes up the contractionary policy. The government can raise the level of tax in this regard to cut down the level of output produced in the economy (Motyovszki, 2013).There can be several justification of the government behind taking up a contractionary policy. The government tries to keep the rate of unemployment within its natural level, it also tries to curb the inflation and prevent any misconception in the form of asset bubble within the economy. The figure below shows the equilibrium in the long run as given by the intersecting point of the long-run supply curve, the supply curve in the short run and the demand curve in which stability is ensured (Ogun, 2014). From the figure it can be seen that the long run supply curve, LRAS is vertical in shape. This can be possible because in the long run it is assumed that there is existence of NAIRU. The economy after utilizing all its resources has no way to deviate and bring changes in its production process. If it can be assumed that in the long run there is sudden increase in demand of any goods which caused a shift of the demand curve outward at AD1 then as a result the price is going to increase to P2. As the resources are already used optimally hence there is dearth of resources to expand the supply the quantity demanded cannot be matched with the supply. Gradually the demand gets reduced due to the increase in the price and the demand curve shifts back to its previous position. Hence, even if there is any change in the aggregate demand curve or supply curve in the long-run, it will be restored back to the original level (Keating, 2013). Conclusion: The write up can be summarized by stating that the 3 different kinds of market interacts and establishes the equilibrium in the market. The main motto of any economic planner is to plan policies that can help the market in attaining equilibrium. The government intervenes in the short-run to restore any discrepancies that crops up. It has been using the fiscal policy as their chief instrument and helping the nation in maintaining the balance between the total demand and total supply of goods, reducing unemployment and curbing the inflation. Ultimately in the long run the economic fluctuations are minimized and a stable equilibrium is restored in the economy. References: Bernanke, B., Antonovics, K., Frank, R. (2015). Principles of macroeconomics. McGraw-Hill Higher Education. Canto, V. A., Joines, D. H., Laffer, A. B. (2014). Foundations of supply-side economics: Theory and evidence. Academic Press. Keating, J. W. (2013). Interpreting permanent shocks to output when aggregate demand may not be neutral in the long run. Journal of Money, Credit and Banking, 45(4) , 747-756. Mankiw, N. G. (2014). Principles of macroeconomics. Cengage Learning. Michaillat, P., Saez, E. (2013). Aggregate Demand, Idle Time, and Unemployment (No. w18826). National Bureau of Economic Research. Motyovszki, G. E. (2013). 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