Aggregate Demand and Supply: Determination and Equilibrium of Employment

Aggregate Demand
It plays important role in the determination of employment. Aggregate Demand at any level of employment is the amount of total money or price which all the entrepreneurs expect to receive from the sale of output produced by a given number of workers employed.

Aggregate Demand
Based on factors: AD = ( f) C+I+G+(N-X) However, in reference to Employment AD based on : AD = ( f) C+I Consumption Demand Investment Demand

1. Consumption Demand :

C = f (Yd)

Disposable income (Yd) Propensity to Consume

Propensity to consume based on two Factors: Objective Factors -

Price level

Taxation policy of the Government Interest rate

Subjective Factors

Willingness to save,

Desire to Imitate others Standard of Living

Investment Demand:
I = f ( r) based on two aspects:

Rate of interest Marginal efficiency of capital; (expected rate of profit by the entrepreneurs) which is based on their estimates of consumer demand for goods and taxation policy of Govt.

Aggregate Demand Curve Aggregate demand curve AD starts from the point of origin which implies that at Aggregate Demand zero level of employment aggregate demand is also Nil AD When ON is employment R then aggregate demand is 2 R OR and so on. 1 R There is rise in aggregate demand because of rise in employment. But it is at diminishing rate, resultantly slope of demand curve start declining as it moves 0 upward to right N N N3
1 Employment

Aggregate Supply

AS = f (N) It is minimum price paid by all the entrepreneurs in the economy must expect to receive from the sale of output produced by the given number of labour employed. Based on: Physical and Technical Conditions of production .

Slope of the Aggregate supply curve is depends on the Physical and Technical Conditions :

1. If the technical conditions are such :

Marginal cost of production does not increase with the increase in production. (Increasing returns to scale) Slope of Supply curve will be straight line.

2. If the technical conditions are such:

Marginal cost of production will rise with the rise in production. (Diminishing returns to scale) Slope of Supply curve will continuously rise rightwards.

Aggregate Supply
(Aggregate Supply/Proceeds)

Aggregate supply curve R2 AS originates from point of origin because at zero level of employment output is also zero,
R1 R N

AS

N1 N2 f Employment

In the beginning AS supply curve rise slowly

Later on rise rapidly, showing number of men employed increased.

Cost of production rises as more people are

employed. Further due to the operations of law of diminishing returns total cost of production rise at an increasing rate.

Once all the men willing to get employment

are employed, then economy reached at Full Employment Level.

 Under the condition of full employment production can not be expanded because of exploitation of all resources but cost will rise. Resultantly, aggregate supply curve assumes as a vertical shape at full employment.

No Deficiency of Demand and employment of labour is guaranteed. No part of income is saved No possibility of Involuntary unemployment but possibility of voluntary unemployment because of wage rigidity

SAYS LAW SUPPLY CREATES ITS ON DEMAND

full

UNEMPLOYMENT
Frictional : unemployment which results from people moving between jobs, and new workers entering the labour force. Seasonal : is defined as, unemployment which is caused by economic slowdowns related to seasonal variations. Examples of this would be agricultural workers, whose activities slow down in the winter

Structural Unemployment : is caused by structural changes in demand patterns. The introduction of labour-saving machines in various industries has created a special kind of structural unemployment called technological unemployment.

Effective Demand
Effective demand is that point where aggregate demand and aggregate supply intersects each other. It is based on two determinants:
Aggregate Demand Aggregate supply

Determination of the Equilibrium level of Employment by Effective Demand

These aggregate demand
Receipts
AS T E AD

and supply curves determine the equilibrium Level of employment in the Economy. Given Competition in the Economy because of opportunities to earn profit the entrepreneur increase the employment.

C 0 N1 NF N 2 EMPLOYMENT

 The opportunities to earn profit exist if aggregate demand is greater than the aggregate supply. Hence, as long as aggregate demand exceeds aggregate supply the entrepreneur will go on employing extra men. When at a level of employment aggregate demand becomes equal to aggregate supply, after this it is not profitable to employ men. Since beyond this point, aggregate supply will exceed aggregate demand , the cost of production incurred on employing a certain number of people. Therefore, when aggregate demand falls short of aggregate supply employment of labour will fall.

 Employments of labour will be in equilibrium at the level at which: AD =AS At point E AD and AS intersect each other which is known as the point of effective demand on ON2 level of employment. At less than ON2 level of employment, aggregate demand curve lies above the aggregate supply curve AS showing that it is profitable to expand the amount of employment. However, beyond ON2 amount of employment , the AD lies below aggregate supply curve AS, which shows that it is no more profitable to employ extra men beyond ON2.level.

Under-Employment Equilibrium: The problem of Demand Deficiency

As per Keynes, economy can be in equilibrium at less than full employment At the equilibrium of employment level ON2, the N2NF remain unemployed.
0 RECEIPTS

AS R
E AD

AD

N 2

N F

Thus equilibrium at E represents an underemployment equilibrium. N2NF persons are involuntarily unemployed. This is due to deficiency of Aggregate demand. This unemployment will be removed and full employment equilibrium through increase in investment demand or consumption can be established, if :
Demand curve shifts upward so that it intersects the aggregate supply at point R and equilibrium in employment is established at full-employment level ONF.

As per Keynes, Aggregate demand and aggregate supply will be equal at full-employment only if investment demand is sufficient to cover the gap between the aggregate supply and aggregate demand. When investment in capitalist countries declines due to the fall in marginal efficiency of capital (expected profit) aggregate demand falls so that equilibrium is established at less than full employment level. As a result, output and income of the community also fall.