What is the adjustment mechanism of disequilibrium situation of AD < AS ?
Answer & explanation
Correct answer: option 1
The correct answer is option 1: Producers reduce the production
Explanation:
When Aggregate Demand (AD) is less than Aggregate Supply (AS), it means that the total demand in the economy is insufficient to match the total supply of goods and services. This creates a situation of disequilibrium.
- In the short run, since prices and wages are sticky, firms cannot immediately adjust prices. However, they will start accumulating unsold inventories because demand is not enough to absorb the supply.
- As inventories build up, firms realize that they have produced more than what is being demanded. To avoid further unsold goods and to adjust to the lower demand, producers reduce their production levels.
Hence, the appropriate adjustment mechanism is for producers to reduce production in response to the mismatch between AD and AS.