Discuss the adjustment mechanism in the following situations :

(a) Aggregate demand is lesser than the Aggregate Supply.

(b) Ex-Ante Investments are greater than Ex-Ante Savings.

(a) Aggregate demand is lesser than the Aggregate Supply.

● When the aggregate demand is less than the aggregate supply it means that the consumers are buying fewer goods than the goods produced by the form.

● The demand for goods and services is lesser than the supply of goods and services.

● This implies deficit demand.

● Due to this deficit demand, the producer would have a pile-up of the unsold goods in their inventory.

● The Producers would reduce production.

● This would lead to a fall in the employment of factors of production, and consequently the income and output will also decrease.

● This reduction in income and output will be sufficient so that aggregate demand is equal to aggregate supply.

● This will restore the equilibrium in the economy.

Graphically it is explained below:

● The X-axis shows aggregate supply and the Y-axis shows aggregate demand.

● AS is the aggregate supply that is at 45 degrees from the origin O.

● AD is the aggregate demand.

● Both of them intersect at point E which is the equilibrium.

● If the AD is less than the AS, as shown in the figure, it will create excess supply. TN is the excess supply.

● The producer would reduce their production, reducing the employment of factors of productions.

● This would lead to a fall in the income and output til the point that AD is equal to the AS.

● The equilibrium is restored at OY level of income/output.

(b) Ex-Ante Investments are greater than Ex-Ante Savings.

● Ex-ante investment exceeds the ex-ante savings when the injections into the circular flow of income are greater than the withdrawal of the income.

● It means that the total consumption expenditure greater than the required amount of consumption expenditure to purchase the available supply of goods and services.

● The low amount of saving means that consumers are spending more on consumption.

● There would be an unplanned reduction of inventory.

● The producers would increase the stock by increasing the usage of factors of production.

● This will lead to an increase in income and consequently greater savings.

● This would continue until saving is equal to investment.

● This would be the equilibrium.

● In the figure x-axis represent and the y-axis represents saving and investment.

● KY' represent the excess of investment over savings.

● The aggregate consumption expenditure is greater than the required amount of consumption expenditure to purchase the available supply of goods and services.

● The producers would increase their stock and increase the employment of factors of production.

● This would increase the income and thereby the savings.

● This would continue until the savings are equal to investment.

● The equilibrium is achieved at point E at Oy level of output.