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11 - AGGREGATE SUPPLY, AGGREGATE DEMAND AND THE PRICE LEVEL

Macroeconomic policy is concerned with minimising deviations between potential and actual GNP. When actual growth exceeds or is too close to potential growth, inflation can arise. If actual growth is much less than potential, there is an underutilisation of the productive capacity and, consequently, unemployment. Therefore, for policy-makers it is important to understand the relationship between the price level and total output if they want to provide a stable economy, in which low inflation is twinned with steady growth and low unemployment. The Aggregate Supply / Aggregate Demand (AS/AD) model is a simple framework of classical derivation in which the equilibrium levels of output and price are determined by the intersection of AS and AD curves. This model offers the basic tools for understanding the effects of fiscal and monetary policy management. In this chapter, besides the description of the national accounts, of potential and actual GNP, the derivation of both curves are explained.

(  QUESTIONS FOR DISCUSSION

Q1. Considerable resources are spent by the statistical authorities in deriving estimates of GNP. From a business perspective, would you say that this exercise is a worthwhile and valuable one?

GNP statistics are useful for business for several reasons. First, firms can use them to compare living standards in different countries and derive estimates over the size of markets which can assist investment decisions. Second, the actual growth rate and the comparison between actual and potential GNP are important for business sales forecasts.  These figures throw light on the likely evolution of market size.  Also they can be useful for predicting changes in economic policy.  For example, a high growth rate usually implies positive expectations for the future trend of sales, helping the process of deciding whether or not a new investment is worthwhile.  But, if the GNP is very close to potential GNP, the fear of the economy overheating might lead the authorities to increase the interest rate.  Such information is useful to business.

Often firms will be as interested in statistics concerning the component parts of GNP, as in the aggregate figure itself.  A huge amount of effort goes into constructing each building block for GNP.  Firms can request the central statistics office to prepare special printouts of information on consumer spending, industry output, exports and imports of specific product groups and demographic features of particular areas.

Q2. What is the difference between actual and potential GNP? How is potential GNP calculated? Of what practical use are potential GNP estimates?

Actual GNP is the value of current output produced by productive factors owned by permanent residents of a country. Potential GNP is defined as the maximum output attainable with full utilisation of productive factors and consistent over the medium term with low inflation. Two observation are worthwhile:

31/07/97

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