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Aggregate Supply and Demand

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Consider the following simplified AE function:
AE = 350+0.8Y+0.1(M/P)
where AE is desired aggregate expenditure, Y is real GDP, M is private sector's nominal wealth, and P is the price level. Suppose that M is constant and equal to 6000.

a) Explain why the expression for AE above makes sense. Why do M and P enter the AE function?
b) Fill in the attached table
c) Plot each of the AE functions-one for price level-on the same scale 45 degree line diagram.
d) Compute the level of the equilibrium national income for each of the values of P.
e) Plot the pairs of price level and equilibrium national income on a scale diagram with P on the vertical axis and Y on the horizontal axis.
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Aggregate Supply and Demand are emphasized.

Solution provided by:
Jayant Kumar, MBA
Education
  • MBA, Indian Institute of Finance
  • Bsc, Madras University
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