After deriving the aggregate demand and the aggregate supply curves, now we are in a position to determine macroeconomic equilibrium, i.e., simultaneous equilibrium of the price level and GDP.
The equilibrium of the price level and the GDP is determined at a point where the aggregate demand curve intersects the aggregate supply curve
The macroeconomic equilibrium is attained at point E0 where the aggregate demand curve AD intersects the aggregate supply curve SRAS. At the equilibrium point the level of GDP is P0. It implies that the total output produced by the firms as shown by SRAS curve equals the desired spending, as shown by AD curve.
(i) If the price levels is less than the equilibrium level, suppose P1 there desired level of output that the firms would like to produce and offer for sale will come down to Y1, whereas the private desired spending at a lower price P1 would rise to Y2. In other words, the desired level of output at a price below the equilibrium level will be less than the desired spending. Consequently, the firms will be induced to increase the output (GDP) until it reaches the equilibrium level Y0.
(ii) Similarly, if the given price levels is more than the equilibrium priced level P0' the desired level of output will exceed the desired spending. Since the aggregate supply exceeds aggregate demand, the firms will have to decrease the level of output and supply less until it reaches the equilibrium level Y0.
“Only at the combination of GDP and price level given by the intersection of AD and SRAS curves are spending (demand) behaviour and production (supply) activity consistent”.
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