The clamorous objective of the government of any economy is to ensure the existence of stability within the nation. The necessary and sufficient condition for stability within an economy is to attain equilibrium (Hubbard & O'Brien, 2015). The term equilibrium has been adopted from physics and is largely used in economics literature. It is a Latin word, which means the condition where the two main opposing forces interact to achieve a state where none of the power of these forces gets nullified and none can influence the situation (Mankiw, 2014). It economic, equilibrium is the state where the nation gets its optimal quantity of goods produced at the price where the supply of goods gets balanced with the demand for the same.
Through this write-up the ways in which any government can intervene and bring the market restore equilibrium within the society has been elucidated. While doing so a brief synopsis of the theories like short run, long run, aggregate demand and aggregate supply has been incorporated. The different types of equilibrium has also been highlighted to understand the way in which it can attain or regain stability if its lost. The role of government in such a situation has also been focused.
Equilibrium in economics is attainable through the process of competition either in free market or in market regulated by the government. The equilibrium can be categorized into several types depending on the nature of occurrence. They can be static or dynamic in nature. Also they are categorized as partial and general equilibrium (Smith, 2015). Along with these four types there is existence of unstable and stable equilibrium. This answer tries to find out the conditions necessary for obtaining static equilibrium. It is a situation where the economy does not deviate from its optimal position and even if it deviate the forces enacts amongst them-selves to restore the level of equilibrium. There are three categorization of market within the economy namely, financial market, product market and labor market. The global stability is ensured when there is smooth functioning and equilibrium in all these three markets. The AD curve has been derived from the famous CKM theory of IS-LM model. The AD-AS curve theory has been punned to explain the long term stability of the market (Rao, 2016).
The demand generated by the consumers within an economy is known as aggregate demand. The AD curve shows the willingness of the entire nation to pay a price for some particular goods and services at varied price level. This downward sloping curve passes through the points where the actual and planned expenditure coincides (Mankiw, 2014).
The economy’s total production of goods supplied at a particular time is known as the aggregate supply of the economy. The supply curve can be divided into three parts namely the horizontal flat line (Keynesian), the upwards rising part and the vertical part (Classical theory). In the long run it is assumed to be vertical in nature (Rao, 2016).
In economics, the term short-run has been interpreted as the phenomenon where at-least one of the components involved in production is fixed. In general, capital has always been assumed to be the fixed factor (Gillespie, 2014). Interaction of the economic components in the short run is as follows:
The figure above shows that the short-run equilibrium is attained at the point where the AD and AS curve meets. The market generated price and quantity is at P and Y respectively. Due to some event it may so happen that the aggregate demand increase. It leads to an outward shift of the demand curve, as shown by shift from AD to AD1 here. Since, it is the short-run and capital is the fixed factor of input thereby there’s no change in the net supply and the AS curve. Therefore, the economy gets a new equilibrium at the intersection of AS and AD1 where the price level is P1 and output produced is Y1. The shift in AD resulted in increased level of output as well as increase in the price level. Under this circumstance, the government may face a dilemma of choosing a proper policy as increased output level is always desirable but increase in the price level is not. As inflation is a plague for the economy, hence the government has to intervene and reduce the pressure on price level thereby balancing the economy (Ireland, 2014).
The long run is that period of time where all the factors of production are variable and production takes place at optimum level by ensuring the economy is at its natural level of employment (Hubbard & O'Brien, 2015). The figure below can help in elucidating the ways in which equilibrium is achieved.
According to this figure it can be seen that initially equilibrium was at the intersecting point of the three curves namely, AD, LRAS and SRAS. It has been seen in the short run that if the AD curve shifts outward a new equilibrium is formed. Here even if the demand curve shifts outward there is going to be an increase in the price level. On other hand, the quantity of goods available is not going to increase since the equilibrium is already using its resources optimally in the long run (Snarr, 2014). Hence, with these restricted supply and high price the AD curve has to shift backward from AD1 to AD, to the level where it can intersect the SRAS and LRAS at a single point.
In case of any problem the government takes up measures with the direct and indirect tool namely, the fiscal policy and the monetary policy respectively. Since, the equilibrium gets re-stored in the long-run hence it is termed as stable equilibrium of the economy (Del Negro, Giannoni, & Schorfheide, 2015).
The above description can be wrapped up by stating that equilibrium is attained whenever the three different types of markets are individually in equilibrium. There is a possibility of distortion in the market under short run. A new equilibrium may be attainable under that scenario. But in long run the equilibrium is fixed at a particular point and digression from the same may initially dampen the economy but it gradually gets restored or forced to get re-stored with the government intervention. Hence, the government has a major role in maintaining the economic balance by ensuring natural rate of employment and low inflation rate within the economy in long-run.
Del Negro, M., Giannoni, M. P., & Schorfheide, F. (2015). Inflation in the Great Recession and New Keynesian Models. American Economic Journal: Macroeconomics , 168-196.
Gillespie, A. (2014). Foundations of economics. Oxford University Press, USA.
Hubbard, R. G., & O'Brien, A. P. (2015). Macroeconomics. Pearson.
Ireland, P. (2014). The Classical Theory of Inflation and Its Uses Today.
Mankiw, N. G. (2014). Principles of macroeconomics. Cengage Learning.
Rao, B. (2016). Aggregate demand and supply: a critique of orthodox macroeconomic modelling. Springer.
Smith, J. (2015). Information equilibrium as an economic principle.
Snarr, H. W. (2014). Learning Basic Macroeconomics: A Policy Perspective from Different Schools of Thought. Business Expert Press.
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