Answer:
If Aggregate Demand (AD) is less than Aggregate Supply (AS), then economy is not in equilibrium because an economy is in equilibrium when AS = AD. When AD < AS, flow of goods and services in the flow of goods and service in economy tends to exceed their demand. As a result, some of the goods would remain unsold. To clear unwanted stocks, the producers would plan a cut in production. Consequently, AS would reduce to become equal to AD. This is how AS adapts itself to AD. In the above figure, equilibrium is struck at point E where, AD = AS. At point Aggregate Supply exceeds Aggregate Demand (AS > AD), It will cause following changes in the economy: (i) Stocks of the producers would be in excess of the desired limit, (ii) Desired level of output for the subsequent year will face a cut and profits will start shrinking. (iii) Levels of income and employment will tend to shrink to the point where, S = /, corresponding to point E in the diagram. Thus, the economy will come back to the state of equilibrium.
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