Fiscal Sustainability and Stable Balanced Growth

Question: Diacuss about the Fiscal Sustainability and Stable Balanced Growth. Answer: Introduction: In order to understand why a stable economic equilibrium requires the economy to operate at an output level at which the long run aggregate supply (LRAS) curve, the short run aggregate supply (SRAS) curve and the aggregate demand (AD) curve intersect, it is important to understand the concept of stable equilibrium (Mankiw, 2007). In economics, equilibrium is a state at which the aggregate demand equals aggregate supply to stabilise the price level in the market (Kamiguchi Tamai, 2011). The application of the concept of equilibrium is vital in economics that makes the economists define economics as equilibrium economics. Meanwhile, to understand the concept of stable equilibrium a figure has been demonstrated herein below: In the above figure, the DD curve presents a downward sloping demand curve and the SS curve presents an upward sloping supply curve. In the above diagram, the equilibrium occurs at point E which is also known as the equilibrium point (Kamiguchi Tamai, 2011). The demand and supply curve are balanced at this point and the equilibrium price is P and the equilibrium quantity is Q. When the price rises or fall from the equilibrium price, the following effects can be seen in the market: Surplus: At price level P1, the quantity supplied is at point B and quantity demanded is at point A. Hence, a surplus can be seen in the market that leads to loss of the producers. Deficit: On the other hand, when the price falls to P2, a deficit can be seen in the market because of excess demand and low supply. It is important for an economy to have a stable equilibrium at which the AD curve, the LRAS curve and the SRAS curve intersect. An economy is found to be in equilibrium, i.e. in a stable state, when the planned injections are equal to the planned withdrawals. In other words, the sum of taxation, import spending and savings (T + M + S) must be equal to the sum of government spending, export revenue and investment (G + X + I) (Mankiw, 2007). Meanwhile, the concept can be also explained as planned aggregate supply equal to planned aggregate demand. The LRAS and the SRAS curve has been used to analyse the relationship between the current level of aggregate demand, the short run aggregate supply and the long run aggregate supply top show the short run stability of the economy in relation to the long run potential of the country. It can be seen that the LRAS, the SRAS and the AD curve intersect each other to form the equilibrium point. The short run equilibrium does not coincide with the full employment level of real output to make the economy achieve its economic potential (Hubbard O'Brien, 2006). Hence, two different cases can occur that has been discussed herein below: Insufficient Aggregate Demand The short run equilibrium is less than the long run equilibrium because of not employing the resources to its fullest. As a result of it, the aggregate demand in the short run is less than the aggregate supply in the long run (Wickens, 2008). Hence, it leads to a negative output gap or surplus in the market that has been presented in the diagram given below: As per the classical theory, it is assumed that the economy can adjust itself according to the situation occurring in the market. With minimum government involvement, the economy adjusts itself to shift the SRAS curve from AS to AS1, resulting in a fall in the price level. On the other hand, with a high level of government interference, the monetary policy is used to increase the level of money supply in the market to adjust the short run aggregate supply (Hubbard O'Brien, 2006). Hence, a new stable equilibrium point is found at point e1 as presented in the diagram given below: Hence, it can be seen from the above diagram that the economy adjust the short run supply in such a way that the AD, the SRAS and the LRAS curve intersect each other to make the fuller utilisation of the available resource and attain a stability in the economy (Wickens, 2008). Excess Aggregate Demand Sometimes, it is found that in the short run equilibrium, where the SRAS equals AD is greater that the potential output at the LRAS. An excess aggregate demand can be seen in the market. At this point the short run equilibrium is at a higher real output level than that the economy can produce (Wickens, 2008). A diagram has been presented herein below for better understanding. In this case, the excess demand creates a labour shortage and the wage level rises in the market. It increases the costs and the short run aggregate supply curve rises upward to the left (Ga?rtner, 2003). Hence, reaching a market equilibrium level at point e1 that is presented in the diagram given below: Hence, it can be seen from the above analysis that to have a stable equilibrium, an economy must produce at an real output level at which the AD curve, the SRAS curve and the LRAS curve intersect each other. Or else, the economy may underutilise or over-utilise the resources that are available in the market in the long run. In other words, any output level below or above the stable equilibrium point may result in a deficit or surplus in the market. References Equilibrium. (2017).Economicsonline.co.uk. Retrieved January 2017, from https://www.economicsonline.co.uk/Managing_the_economy/Equilibrium.html Ga?rtner, M. (2003).Macroeconomics(1st ed.). Harlow, England: Financial Times/Prentice Hall. Hubbard, R. O'Brien, A. (2006).Macroeconomics(1st ed.). Upper Saddle River, N.J.: Pearson Prentice Hall. Kamiguchi, A. Tamai, T. (2011). Are Fiscal Sustainability And Stable Balanced Growth Equilibrium Simultaneously Attainable?.Metroeconomica,63(3), 443-457. Mankiw, N. (2007).Macroeconomics(1st ed.). New York: Worth Publishers. Wickens, M. (2008).Macroeconomic theory(1st ed.). Princeton: Princeton University Press.