When customers want something and businesses have what they want, you could say that supply and demand is equal. In this lesson, we’ll learn why this happens and what factors contribute to that state of equilibrium.
Macroeconomic Equilibrium Defined
Did you ever have a lemonade stand as a kid? If so, you know how exciting it was to sell a cup and gather those new, shiny coins. Neighbors would walk over, buy a cup, and hopefully tell others of the newest business venture on the block. When the day was over, the goal was to sell every cup of lemonade. However, there was more to just making sure you sold every cup.
You also wanted to be sure you had enough cups for all the neighbors that needed that thirst quenching cup of lemonade on a hot summer day. You see, what you may not have realized as a kid, is that you were striving to reach macroeconomic equilibrium, in which the quantity of lemonade demanded equaled the quantity supplied.
In order to fully understand how we arrive at an equal state, let’s define some key terms first. Macroeconomic equilibrium is a condition in the economy in which the quantity of aggregate demand equals the quantity of aggregate supply. If there are changes in either aggregate demand or aggregate supply, you could also see a change in price, unemployment, and inflation. For example, if the aggregate demand for your lemonade is too low, then your new business venture won’t need to keep making as much lemonade and if you hired any friends to help you run your lemonade stand, you may have to let them go.
This is because if customers are not buying lemonade, you won’t be making money, which means you won’t be able to pay any of your friends. When this happens at large companies, workers are often laid off, which ultimately causes the unemployment rate to increase.
Aggregate Supply and Demand
The total economic output of goods and services in an economy at a certain time period is known as aggregate supply. For instance, aggregate supply is the total amount of lemonade made during a specific time. Factors such as labor, capital, natural resources, and technology affect aggregate supply in the long run. For your lemonade stand, this could mean the amount of lemonade you are able to make depends on how many friends are helping you and how much money you, or your parents, have to keep your stand operating.Aggregate demand is the opposite of aggregate supply in that it is the total demand for goods and services in an economy during a specific period of time.
This is all the cups of lemonade the neighbors want during a specified time. Aggregate demand is often affected when there is a change in price level. What I mean is if there is a decline in the price level in an economy, aggregate demand will increase.
This is because consumers will have more money left over to make more purchases. On the other hand, if there is an increase in the price level, aggregate demand will ultimately decrease. This happens because higher prices mean less money left over to buy more goods.In terms of your lemonade stand, if the price decreases, more neighbors might buy more cups, increasing demand. However, if the price of your lemonade increases, your neighbors might not be able to afford to buy more cups of lemonade, which decreases demand.
Achieving Equilibrium in the Economy
We know that an economy is at a state of equilibrium when the quantity demanded equals the quantity supplied. Like mentioned before, this happens when the amount of cups of lemonade demanded by your neighbors equals the amount of lemonade you made. There are important factors that can affect equilibrium. Let’s take a look at a few examples:If the quantity demanded is more than what is available, companies increase their prices because they know consumers will compete for the small supply of goods.
For example, if you have a huge line of neighbors wanting a cup of lemonade and only a couple glasses left, you might increase the price from $.25 to $.50, because you know the neighbors will compete to buy those few cups.Keep in mind, that being a good business person, you also realize that your lemonade is highly demanded. You therefore decide to make more lemonade and open your stand up for one more day. Opening one more day means eventually, the cups of lemonade demanded by your neighbors will equal the amount of lemonade you supply.
Again, reaching equilibrium.It is also important to note that governments can intervene in an economy in an attempt to help it reach equilibrium. This is known as fiscal policy and occurs when the government makes decisions regarding spending and taxation. Increasing spending and decreasing taxes tends to increase demand as people and businesses have more money to spend. For example, if the government reduces your neighbor’s taxes, they may have more money in their pockets to buy your lemonade. A decrease in spending and an increase in taxes have the opposite effect.
Macroeconomic equilibrium is the state of the economy when the quantity of goods and services supplied in an economy equals the quantity of goods and services demanded in an economy.
The total amount of goods supplied during a specific time is known as aggregate supply, whereas the total amount demanded during a specific time frame is known as aggregate demand.Naturally, the economy tends to find equilibrium as buyers and sellers change their actions in relation to the price level. However, sometimes the government intervenes in an economy to affect spending and taxation through fiscal policy.