INTERMEDIATE MACROECONOMICS Essay Example | Topics and Well Written Essays - 1500 words

INTERMEDIATE MACROECONOMICS - Essay Example The ASF line was a vertical line with interest rates measured along the y axis. Thus, the ASF line was unresponsive to changing interest rates at a given level of output (GDP). Both Money and Supply are unresponsive to interest rate changes as well. It is assumed that the GDP is at a profit-maximizing level. Hence, any change in the level of APE will not be complemented by a similar rise in ASF. This is because when APE increases, and the buyers hunt for cash through funding, the ASF remains the same as money supply and the velocity of money are taken to be unresponsive to any changes in interest rates. In order to cope with this excess demand, the banks will offer higher interest rates, and keep going higher till it overshadows the excess demand. Even though demand was high, there was no real increase in expenditure because APE was unresponsive, and thus businesses never had any incentive to raise prices or output; hence, GDP remained the same too. The APE curve will shift back to i ts position eventually owing to increased interest rates which curb demand. Same is the case when APE falls; price and output are unaffected. It is only when the ASF, being a vertical line still in classical macroeconomic theory, shifts to the right or left is the price and output of product (GDP) affected. When funding (ASF) increases, interest rates fall which in turn raises APE. The economy will find a new equilibrium ahead of the current GDP, giving an incentive to producers to increase prices (producers in this version of the macroeconomic theory are taken to be satisfied at current level of output). Once prices are increased, it curbs funding (ASF), which in turn increases interest rates. When rates are increased, the APE falls until all three, interest, ASF, and APE are back at the initial equilibrium. Hence, it could be concluded that a rise in ASF would only cause inflation without any chance in output or employment. As such, a fall in ASF would result in a loss of APE, cau sing loss of demand and higher interest rates. Businesses will counter with lower prices, causing ASF to rise again and APE to go back to its original level, without any change in output or employment. This was the same case with any fall in GDP, so that if output fell, and prices rose, resulting in less ASF, all businesses had to do was readjust their costs and consequently prices of goods in order to increase expenditure (APE) back up again and with the help of lower interest rates, ASF to rise up back to its original level. Output would remain unaffected. According to classical macroeconomic coordination, all these changes were to take place over a period of time. However, the Great Depression of 1929 saw unparalleled levels of unemployment and loss of GDP which brought a change in theories since. The first change was on the control of expenditure. It was seen that when APE rose, the corresponding change in interest rates would not be able to fully engulf the new rise in demand. Some demand would be funded affecting the conditions of the market, causing temporary rise in output and inflation. On the contrary, if APE fell, interest rates would also remain unchanged until manufacturers responded by cutting costs and prices. However, the macroeconomic coordination’s tendency to find the equilibrium by altering the prices to reach GDP at full-employment is faced with two problems. Firstly, APE can fall to such