Question

Explain the adjustment mechanism to attain the level of effective demand if ex-ante aggregate demand is more than ex-ante aggregate supply.

Answer 1

If ex-ante aggregate demand is more than ex-ante aggregate supply, it means that the households and firms are planning to consume more than what the firms intend to produce. Thus, the inventories will fall below the desired level. To restore the desired level of inventories, producers may increase output and employment in the economy. This mechanism will continue till the equilibrium is reinstated and effective demand can be restored.