One of the salient features of this document is to distinguish between the short-run and long-run aggregate supply curves and explain why they are important for the definition of a macroeconomic equilibrium. The Aggregate Demand model tries to examine the effects on the real GDP and price level of increases in American tourism to the UK. 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 that is driven 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. 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.
[...] “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. [...]
[...] So, the use of the aggregate supply aggregate demand model has permited 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 creates inflation in the UK. [...]
[...] 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. [...]
[...] The green curve on figure 1 represents the long-run aggregate supply curve: it shows the relationship between the quantity of real GDP supplied and the price level in the long term, when real GDP equals potential GDP. Figure the short and long-run aggregate supply curves In the long run, the prices of factors of production, like the wage rate for example, are not fixed, so an increase in the price level will bring an increase by the same amount in the costs of production. [...]
[...] 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. [...]
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