One of the goals of economists is to try to predict the changes in the state of the UK economy. Thus they are interested in the economic growth –given by the growth of potential GDP-, the inflation and business cycle fluctuations. The Aggregate Supply – Aggregate Demand model permits to understand, and even to predict the changes in these three features of macroeconomic performance. Indeed this model permits to determine the level of real GDP and the price level when the economy is at its equilibrium. Thus, in this essay, we will use this AS-AD model to predict the effects on real GDP and price level of increases in American tourism to the UK. To do so, we will first have to describe how this model works both in the short and long-run. To understand the AS-AD model, we need to explain the concepts of short-term and long-term aggregate supply.
[...] So, the use of the aggregate supply aggregate demand model has permitted to describe the effects on price level and real GDP of increases in American tourism to the UK. In the short term, it causes an increase in both price level and real GDP. This is a period were factors of production are more than fully employed. After an adjustment process takes place, real GDP goes back to its first value –real GDP- but price level increases again. Thus, in the long term, increases in American tourism create inflation in the UK. [...]
[...] Indeed, real GDP equals aggregate expenditure which is itself equal to the sum of consumption expenditure, government expenditure, investment and net export. A rise in foreign tourism to the UK will make the consumption expenditure to increase, or, according to some economists, the net export. Ramesh Durbarry, for example, argues that “tourism is the largest invisible export”[5], but an export which takes place at the point of production. The increase in the aggregate demand will be followed by the decision of the firms to increase production and prices. [...]
[...] “Along the adjustment path [of the short-run aggregate supply curve], real GDP falls and price level rises”[7]. When the adjustment process is finished, we can see on figure 6 that, following the increase in American tourism, price level has increased from PA to PC, but that real GDP has came back where it started and is again equal to potential GDP. Thus the same amount of goods and services are produced, but at higher costs and higher prices. To study the effects of increases in American tourism to the UK, we have to repeat this same reasoning several times. [...]
[...] Figure Three types of macroeconomic equilibria So, the concepts of short and long-run aggregate supply are very important in the definition of a macroeconomic equilibrium, and it is really important to make the distinction between these two time-frames. The determination of the macroeconomic equilibrium in the AS-AD model permits us to study the effects on real GDP and price level of a change in aggregate supply or a change in aggregate demand. Increases in American tourism in the UK bring a rise in aggregate demand. [...]
[...] So, an increase in the price level causes an upward movement along both the short-run and long-run aggregate supply curves, but it makes the quantity of real GDP supplied increase in the short run whereas it remains unchanged in the long run, as we can see it in figure 1. The purpose of the Aggregate Supply Aggregate Demand model is to determine the macroeconomic equilibrium in order to study changes in price level and in real GDP. To study macroeconomic equilibria, we need to combine the concept of aggregate demand to the concepts of short and long- run aggregate supply we have just studied. [...]
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