Business – Demand and Supply

nswer the following question ensuring that you apply economic principles or theory related to understanding the health of the economy and the need for government intervention to inform your analysis and support your decisions.

Question – Using an appropriate diagram, explain the concept of a stable economic equilibrium and provide your assessment of whether or not the Australian economy is currently at a stable equilibrium.


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Aggregate demand and supply

Explanation of stable economy fromFig-14.9
A stable Economy is an economy that experiences low inflation and constant growth.
From the figure 4.9, stable economy occurs when the price remains constant, and the country’s
GDP is growing at a steady rate. Inflation is the cause of instability in the economy. At a stable
economy, the equilibrium potential GDP and price level is determined by the point of connection
of the Long Run Total Supply curve (LAS), the Short Run Total Supply curve (SRAS) and Total
Demand (AD) curve. Where the three curves intersect forms the equilibrium point of a stable
economy. The aggregate Demand line displays the connection between the amount of real Gross
Domestic Product (GDP) required by the firm, governments, households, gross exports and the
price level. Short Run Collective supply (SRAS) curve reflects the connection between the
amount of the real GDP provided and price level in short run ("AmosWEB is Economics:
Encyclonomic WEB*pedia"). AD line has a negative gradient sloping from left to right, and it is
affected by some factors that may change its position by either shifting to the right or left. These
factors include; interest rate, personal income taxes, government purchases, the household
expectation of their future revenues, exchange rate among others. Increase in the in the interest
rate increases the cost to the firms and households hence reducing investment which in turn
increases the general level of the price.

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Figure 14.9

Long- run total supply (LRAS) curve shows the correlation between the general level of
prices and the amount of real GDP provided in the long term. The arc indicates that increase in
the price level does not produce any change to the level of real GDP. The nature of the curve is
usually vertical at the line of real GDP. There are factors which can affect the LRAS, some of
them include: resources, technological advancements, machinery and equipment among others.
The Short-Run Aggregation supply is a curve that shows that a firm will produce more in the
response of high prices in the short run. The prices of output rise at a lower speed than the rate of
the prices of input. Some factors are associated with the shifts of the curve which include:
unexpected changes in the natural resources, expected changes in future price level among

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Explanation of contraction
It’s a period in which a country’s GDP decline. It is also known as negative growth
where a country experience high inflation rates and the GDP reduces significantly. There are so
many factors associated with contraction of the economy, and some of the causes of shrinkage
include political instability, War, high interest, rates high import than export, high saving rate
than investment rate among others. However, the government plays a significant role to reduce
and minimize contraction of the economy. The government can come in and apply appropriate
fiscal and monetary policy that will help to reduce inflation and encourage investments.

Explanation of figure 14.10
Figure 14.10

$980 $1000 Real GDP (in billions)

Decrease in export increase the domestic Aggregation supply at a higher rate than the
increase in the Aggregation Demand. It causes a fall in the price causing a left shift of the
Aggregate Demand curve. The SRAS curve will move to the right and the price shifts from$100
to $96. The SRAS curve shifts toward the right due to increase in the domestic supply.
The AD curve is affected by the level of certain factors. A decrease in the investment
will reduce the level of production which in turn leads to a reduction of Unemployment. The
earning will reduce and hence the consumption rate of consumers will be reduced. It will cause
the AD curve to moves to the left. The price at equilibrium will move from point A to B and cut
from$100 to $98 followed by a decrease in the GDP to $980. However, the economy is a self-
adjusting mechanism, and automatic reactions of this changes, the personnel, and the companies
will change to the lower price level than the predicted. Expenses will reduce, and this will lead to
a right move of SRAS. The right shift of SRAS causes the price and real potential GDP to move
from point B to C. the price falls again from $98 to $96, but the GDP goes back to its initial
value of $1000.
Explanation of the economic expansion with fig-14.11
Figure 14.11

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$1000 $1030 Real GDP (in billions)
Expansion in the economy is caused by an increase in the investments which increases
the production level. Increase in the output leads to an increase in labor demand which intern
increases the earning of the consumers. Consumption is directly proportional to income in that
increase in earnings increases the consumption level (Ushakov 54). This increase in investment
makes the total demand curve to move to the right causing the equilibrium price to change from
point A to point B. It increases the price level from $100 to $103and the GDP changes from
$1000 to $ 1030. However, the economy always has an automatic response to the variations in
the market. As the workers and the firms try to adjust to the changes in the price level is higher
than the expected, there will be an increase change in the SRAS causing it to move to the left.
Because of this, the price level and the real GDP changes from point B to point C. the potential
GDP changes from $ 1030 back to the initial value of $ 1000 and the price level rises again to

Expansion in an economy is caused by an increase in the investment which in turn
increases production. It will create an increase in the level of employment hence increasing
consumer income. When the customers have enough income, their level of consumption also
increases, and this raises the Aggregate demand which will make the AD curve to move to the
right (Farmer 45). The equilibrium price level move from point C to the unmarked position at the
same price level of $98 as point B. Also, the real potential GDP will increase relatively. In
response to this, the workers and firms in the economy reacts to the price level being greater than
projected, expenditures will rise and make the SRAS curve to change to the left. The equilibrium
price level shifts from$98 to $100 at point A. the GDP also reduces to $1000 as it was in the
initials. Some factors can lead to the AD curve changing to the right one of them being an
increase in the investment, reduction in interest rate, increased government spending among

On figure 4.1, expansion is the increase in the economic level of services, goods, and
activities. Expansion causes the real Gross Domestic Product to grow at a high rate. It may be
due to external environmental factors like technological change or weather conditions or internal
factors of the economy such as monetary, fiscal policies, regulatory policies, interest rate,
availability of credit or other impacts that may affect the producers such as incentives (Lipsey
32). During expansion, the investment rate is usually high, production increases followed by an
increase in the level of employment to fit the increased output. The consumer earning increases
and the Aggregation demand rises shifting the AD curve to the right. It results in the price level
to move from point A to B. the real GDP also increases from $1000 to $1030. As the workers
and the firms adjust to the change in the general price level which is greater than the projected,

expenditures rise causing the SRAS to move to the left. The price level and the real GDP
changes position from point B to point C. The price level rises from $103 to $106 and the real
GDP reduces from $1030 to $1000. The economy goes back to its usual equilibrium point but at
a higher price level.
In conclusion, the economy of a country plays a prominent role in determining the living
standards of its citizens and its relation to the international markets. The governments are the key
player in ensuring the stability of the economy by avoiding factors that can change the pattern of
the economy ("Stability and the Economy: Cooperative Game Theoretic Implications for
Economic Policy in a Dual-Sector Economy"). The factors that can lead to an economy going to
recession is war and unregulated trades dealing with huge amount of money. In the year 2008,
there was a massive financial crisis that caused a lot of troubles to the economy worldwide, and
the government should avoid the factor that had caused the crisis. Monetary and fiscal policies
are essential regulators of the economic stability. While the monetary policies aimed at
regulating the amount of money in the economy, fiscal policies encourage and the controls the
investments in the country.


Works Cited

"AmosWEB is Economics: Encyclonomic WEB*pedia." AmosWEB: Economics with a Touch
of Whimsy!, 2017,
Farmer, Roger E. A. Aggregate Demand and Supply. National Bureau of Economic
Research, 2007.
Lipsey, Richard G. "The Aggregate Demand Aggregate Supply Diagram." Famous Figures and
Diagrams in Economics, 2015.
"Stability and the Economy: Cooperative Game Theoretic Implications for Economic Policy in a
Dual-Sector Economy." Stability: International Journal of Security & Development,
vol. 2, no. 2, 2013, p. 41.

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Ushakov, D S. Urbanization and Migration As Factors Affecting Global Economic
Development. 2015.