Stable Economic Equilibrium

Question: Explain why a stable economic equilibrium requires the economy to be operating at an output level at which the aggregate demand curve, the long run aggregate supply curve and the short run aggregate supply curve all intersect. Answer: Introduction: A stable economic equilibrium requires the economy to be operating at output level at which the aggregate demand curve, the long run aggregate supply curve and short run aggregate supply curve all intersect because of the following economic principle; the quantity demanded adjust to equal the quantity supplied. In long run, natural forces influence the adjustment of supply quantity and demand quantity to attain the equilibrium quantity. A look at long run aggregate supply helps in explaining the above factor. The quantity of output churned to the market by firms defines the price level in the market (Harcourt Kriesler, 2013). As firms supply products into the market, prices tend to change. This adjustment often affect demand pattern within the respective markets. It has been established that when the price of a product rises, firms producing the respective product would increase output quantity with a view of benefiting from the high price in the market. As the quantity supplied overwhelms the market, the excess supply would trigger a drop in demand price (Tieben, 2012). In this case, the producing firms would be adjusting to the demand patterns in the market so that the resultant price, quantity, and demand are at equilibrium. Using the case of natural employment supply in long run, the aggregate supply curve would appear as a vertical line at in a given level of economy output. The employment supply in the respective economy has a single level at which it attains natural level. It follows that the supply curve would adjust to the natural level by shifting towards the right until the employment supplied intersects at real wage (equilibrium state) (Lengwiler, 2006). In this case, the employment market would respond to wage presented in the market to determine a point at which aggregate employment supply and aggregate wage intersect. The natural forces tend to push the adjustment of the employment supply and wage to intersect (Tieben 2012). It is observable that high price P4 would attract high supply of employment (labour), but the economy would not sustain it. This would push the aggregate wage to P2 where the supply quantity intersects with the demanded quantity. Here, the wage defines the quantity supplied and quantity demanded. From this illustrated, in long run natural forces pushes the demand quantity to shift leftward while supply quantity shifting rightward to intersect at equilibrium. In this state, the quantity required by the economy equals the quantity supplied. The demand pattern in an economy affects the supply curve and determines the equilibrium real gross domestic product (GDP) and price level in the long run. The increase in demand within the economy will destabilise the economy by putting more pressure on suppliers to meet the needs of market (Dixon Jorgenson 2013). It follows that in the short run, the economy would witness a shortage of supply then the market shall adjust to fill the demand gap. The graph below is illustrates the way quantity of demand behave in short run then settles in the long run. At AD1 the demand quantity is at equilibrium meaning that the economy is at equilibrium. Increase in aggregate demand would push the economy to disequilibrium because the supply quantity will not intersect with the demand quantity (Devereux Sutherland, 2007). The rise in demand pushes the price to 1.18, but at this point the economy is not able to sustain this price. It means only a few firms shall be able to pay wages at this price. In the long run, natural forces shall trigger the economy to invest more in supplying employment into the market (Boyes Melvin, 2012). With the increased supply of employment the quantity demanded will try to adjust until it intersects with the quantity supplied (Starr, 2011). In the above graph, it is observable that high price at 1.18 would only attract a few firms to buy the employment. In this case, the wage price for employment would influence the quantity supplied and demanded. In most instances, the consumers consider other factors such as sustainability of the demand price. On the account of this view, demand at high price shall is only tenable in short run (Monroe, 2009). In the above graph, AD3 is only realizable in the short run because the economy cannot continue supporting decreased demand at high supply, therefore natural forces shall push the demanded quantity to the right intersecting with the supplied quantity at AD1. In conclusion, long run equilibrium takes place at the point of intersection aggregate demand curve and aggregate supply curve. The long equilibrium appears at three different price values, but the potential output of the economy remains the same per year. In this case, the shifts that of the long run aggregate demand to the right or left largely depend on the price level. It has been established that as the demand level rises, the producers respond by setting prices slightly higher than the equilibrium price. Interestingly, the quantity produced in the economy remains nearly the same. It follows that the natural forces would then shift the aggregate quantity supplied by increasing it. This development would shift until the aggregate supplied quantity intersects with the aggregate demanded quantity. In this case, the price tend to shift from low to high and back to the equilibrium level while the potential output of the economy remains the same. References Boyes, W. Melvin, M. (2012). Economics. New York: Cengage Learning. Devereux, B. D. Sutherland, A. (2007). Solving for Country Portfolios in Open Economy Macro Models, Issues 2007-2284. Washington DC: International Monetary Fund. Dixon, B. P. Jorgenson, D. (2013). Handbook of Computable General Equilibrium Modelling. New York: Newnes. Harcourt, C. G. Kriesler, P. (2013). The Oxford Handbook of Post-Keynesian Economics, Volume 2: Critiques and Methodology. New York: OUP USA. Lengwiler, Y. (2006). Microfoundations of Financial Economics: An Introduction to General Equilibrium Asset Pricing. Princeton: Princeton University Press. Monroe, K. H. (2009). Can Markets Compute Equilibra? Washington DC: International Monetary Fund. Starr, M. R. (2011). General Equilibrium Theory: An Introduction. Cambridge: Cambridge University Press. Tieben, B. (2012). The Concept of Equilibrium in Different Economic Traditions: An Historical Investigation. London: Edward Edgar Publishing.