Run Equilibrium the Aggregate Supply Assessment

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The hiring would then lead to an increase in consumer spending, which could encourage other businesses to increase their hiring as well. The increased business investment could allow companies to develop processes, technology and capacities that will allow them to not only increase their presence in domestic markets but to increase their exports as well. The Keynesian as-AD model assumes that this multiplier will result in an increase in aggregate demand and aggregate supply, if governments increase spending. For the government, the multiplier is expected to decrease with the size of the investment, so the ideal amount of spending is not infinite, but is constrained by a declining multiplier, which would lead to an equilibrium level of government spending.

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The as-AD model illustrates another reason by government spending cannot be infinite. As and AD increase, P also increases. This means that inflation occurs as demand and supply in the economy increase. In order to respond to inflationary pressure, the government must increase interest rates. These rates are the cost of borrowing, and as they increase they move towards the decreasing multiplier effect, finding an equilibrium point at which the cost of borrowing outweighs the benefits -- this is the natural point where government spending is constrained.

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