Answer to Question #264039 in Macroeconomics for Bri

Question

Draw and explain an aggregate demand and supply diagram to illustrate the fact that the economy is experiencing a capacity constraint.

Answer 1

Capacity constraint refers to a rule that governs the quantity of commodities that can be awarded to a supplier. Using a capacity constraint, a business can be awarded to a preferred supplier or the volume of business can be limited for a given supplier.

As shown in the diagram above, when a firm temporarily overproduces, excess inventory will be created, prices will subsequently fall and consumers will incline their purchase in order to offset excess supply. This will amount to a vertical supply curve.

In case there is an increase in demand, prices will rise but the output will not change significantly. This is as shown in the diagram below: