Essay about Economics: Economics and Aggregate Demand

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Economists study many issues, but all of them stem from the central economic problem of scarcity. Discuss

Economics can be defined as the study of how governments, firms, nations and individuals make their choices on the allocation of scarce resources in order to satisfy their unlimited wants. This subject can be divided into Microeconomics, which centres round single consumers, and Macroeconomics which focuses on the performance of the collective economy (Economics, Investopedia). Scarcity, according to Sloman, Hinde & Garrat (2013), can be defined as “the excess of human wants over what can actually be produced to fulfil these wants.” The pursuit for balance between consumer wants and the efficient production of goods to fulfil them is debated to be the main problem faced by all societies and individuals in their economy. In this essay I shall discus the extent to which scarcity holds responsibility for the Global Financial Crisis focusing on factors of production, demand and supply, policies in the business environment and rational choices made by firms.

In order to maintain social, economic and environmental sustainability, factors of production need to be considered to avoid the problem of scarcity as there are limited quantities of natural resources and production capacity that affect the number of goods that can be manufactured. The factors of production include Land, Labour, Capital and Human Capital. Land refers to the fixed amount of natural resources that, within scarcity, limit the extent of production. While labour refers to the work force available in the economy which is limited in both numbers and skills but increases with population. Capital is the limited supply of machinery, buildings, factories, equipment and transportation that can only be increased with investment and development in technology. While Human Capital is the skills and knowledge available that contribute to the betterment of the economy through research and education (Factors of Production, Business Dictionary)

Demand and Supply are therefore vital in the allocation of resources as production depends on their balance. Consumer Demands, relating to wants, are infinite and virtually boundless as mentioned above however supply, relating to resources, on the other hand is limited as the amount that firms can produce depends on the technology and resources available. Due to the problem of scarcity, potential demands can exceed potential supplies and vice-versa and to avoid this, total spending in the economy will need to be equal to the total production therefore demand and supply have to be adjusted in order to achieve this. This is referred to as Market Equilibrium occurs when quantities supplied and demanded are equal resulting in price stability as there is neither shortage nor surplus in the market (Business Dictionary). Market clearing then occurs as the buyers and sellers have agreed on a trade price leading to a balance in the quantity that consumers want to purchase and sellers are willing to produce and provide for them. (Mind Tools)

However, the imbalance between demand and supply can result in increased price in the situation of excess demand or shortage and a decreased price in a situation of excess supply. Macroeconomic effects of the imbalance between aggregate demand and supply in terms of excess aggregate demand in relation to aggregate supply can result in inflation and balance of payments deficits. Inflation is the general rise in the levels of prices in the economy due to the substantial increase in aggregate demand that results in firms raising their prices. Firms do so because they are aware of their ability to sell their products as before or better even though prices may be higher and they are able to continue making a profit. The balance of trade deficits, which can be defined as the excess of imports over exports, would also occur as a result of the excess aggregate demand in relation to aggregate supply. This,
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