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Question : 16
Total: 47
Define effective demand. Discuss how, effective demand can be restored, if ex-ante Aggregate Demand (AD) is more than ex-ante Aggregate Supply (AS).
Solution:
Effective demand is a representation of the actual amount of goods or services that buyer are purchasing in a given market.
When Aggregate Demand is more than Aggregate Supply in an economy, it will lead to inflationary pressure in the economy when price level and wage rate tend to rise. The inflationary gap encourages producers to increase their output to meet the excess demand. It will lead to gradual increase in income and output and ultimately Aggregate supply will also increase to the point to be equal to aggregate demand.
When Aggregate Demand is more than Aggregate Supply in an economy, it will lead to inflationary pressure in the economy when price level and wage rate tend to rise. The inflationary gap encourages producers to increase their output to meet the excess demand. It will lead to gradual increase in income and output and ultimately Aggregate supply will also increase to the point to be equal to aggregate demand.
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