In an economy, Aggregate Demand is less than Aggregate Supply. Explain the changes that will take place in this economy.
When AD < AS in an economy, it creates a deflationary gap. It creates deflationary pressure in the economy and the price levels tend to fall. Deflationary gap discourages the producers to increase output due to increase in inventory levels. It leads to gradual decrease in Aggregate Supply and the economy attains equilibrium where AD = AS.