In the twentieth century many classical or non-classical Economist claimed that the Economy will always be at or close to natural level of Employment (Keynes, 1936). In Appropriate it is the great features of the economic system in which we live, while variation in output and employment will make the economic system violent. The recession in United States was resolved by practicing the Keynes policy. Keynes Expansionary policies were also implemented by Sweden and Germany but the true success of Keynes can be seen after the World War II which provided a boom to Economy (Keynes, 1937) Evidence indicates that natural employment will be for limited period.
In order to start the discussion I will provide with the definitions of both Aggregate Demand and Aggregate supply. According to (Blanchard,Amighini,Giavazzi, 2010), Aggregate Demand represents the Combination of price and output corresponds with the equilibrium in the goods and financial market. Further in order to understand above statement we can elaborate Aggregate Demand. Aggregate Demand shows the relationship between Equilibrium markets for goods with equilibrium market for money. If there is no shadow economy then total Expenditure(Y) can be equal to total GDP or total income earned, so consumption, investment and government expenditure can be found in the GDP or total expenditure model. Many Entrepreneurs believe that changes in consumer consumption will affect price and then later investment. However economists consider that investment will be dependent on interest rate. Change in price will also affect aggregate demand (AD). Hence AD is the reflection of all of Equilibrium points between IS/LM model this can be seen in the graph below Figure1
(Figure1 Source Blanchard)
[The initial price is (P) and output(Y) with the point (E) .As the price rise to P1 the demand for money rises because now the economy will demand more money for transactions but the real money supply will fall (as the real money supply=M/P) and this will implies LM curve to shifts upwards (LM1) leading to decrease output from(Y) to (Y1) and increase interest rate from point (r) to (r1)](Blanchard 2010).This process will further move as LM further shift to LM2 with the increase in price and interest rate
In addition the aggregate supply captures the effect of output on the price derived from Equilibrium in the labour market.(Blanchard,Amighini,Giavazzi, 2010). Supply of labour can be determined by wage rate and the price level so economist determined the following equation
the nominal wage will be set depending on the expected price on the unemployment rate,(u) whereas the price in economy will be set the firms that will be equal to nominal wage multiplied by mark-up plus 1 (Blanchard,2010).The aggregate supply is thought to be equal to natural level. The aggregate Demand and Aggregate supply will make the...