Q. 185.0( 1 Vote )

Explain how the l

Answer :

Effective demand is attained at the point where aggregate demand is equal to aggregate supply. Aggregate demand depends on the level of consumption and investment in the economy. Consumption always depends on the level of income in the short run. Aggregate demand curve will start from the y-axis because of the autonomous consumption. Therefore the aggregate demand curve depicts the nature of both investment and consumption.

Aggregate supply implies the total money supply in the economy which depicts income of the economy. It is the straight 45° line. The effective demand can also be the equilibrium level of income in the economy.

When the Aggregate demand is more than aggregate supply then equilibrium should be maintained by reducing the consumption expenditure.

The aggregate demand is greater than the aggregate supply is the condition at the point A. in that situation the economy will be facing inflationary gap. To overcome the problem of the inflationary gap the economy can promote savings, increase total output, increase tax rate etc.

This will increase the AS then the point shifts from the point A to Point E where the equilibrium is being obtained.

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