Equilibrium Output and Price:
It is mentioned above that aggregate supply curve (AS) is upward sloping (in the short run) while aggregate demand curve (AD) is downward sloping. Through the intersection of aggiegate supply and aggregate demand curves we obtain equilibrium levels of output and prices.
In Fig. aggregate supply is given by the line AS1 and aggregate demand is given by the line AD1 Corresponding to the equality between AS1 and AD1 we find that the equilibrium level of output is Q1 and equilibrium price level is P1. Suppose there is a downward shift in aggregate demand from AD1 to AD2 due to changes in the levels of its components. Accordingly. the equilibrium levels output and price will change to Q2 and P2.
Certain questions may be shaping up ii: your mind at this point. How soon does such a change in output level take place? What is the impact of such a change on the level of employment? If Q, represents full employment equilibrium, does the economy ever regain its full employment output level?
When there is a decline in AD the immediate impact is a downward shift in the output level. Consequently, there is a rise in unemployment in the economy which pushes the wage rate downward. The decline in wage rate is likely to reduce cost of production and hence price level. As a result, the AS curve will shift downward. 'The whole process. however, takes time as the decline in nominal wage and prices is not instantaneoys. Therfore, in the short run output declines below full employment level but in the long it returns to its full employment level. So long on output remains below full employmdnt level, there is a thendency for wage rate to decline. Through adjustments in wage rate and prices the output level recovers to its full employment level, although with considerable delay. Once full employment is realised, increase in AD will result in price rise. Thus fluctuations in output, wage rate and price level are a partof the process. Such fluctuations are often systenlatic and called business cycles.