Question

How to show Aggregate Demand and Short Run Aggregate Supply declining on a AD-AS diagram and where to mark the equilibrium price

Answer 1

Answer to the following question:

(Refer to the above diagram) In the figure above, we can see that the SAS is the short run supply curve and the AD is the aggregate demand curve. The initial equilibrium point is at point E1 (SAS1=AD1) where the equilibrium price is OP1 and the equilibrium quantity is OM. Now, suppose the aggregate supply falls from SAS1 to SAS2 and shift to the left and the new equilibrium point is achived at point E2 (SAS2=AD1), where the equilibrium price is OP2 and the equilibrium quantity is ON. Now, again if the aggregate demand also falls fram AD1 to AD2 along with the aggregate supply (from SAS1 to SAS2) then the equilibrium will shift to the E3 point (SAS2=AD2) where the price is equal to OP1 and the equilibrium quantity is OL.

One thing must be noted here is that, if the fall in aggregate supply and aggreate demand is equal, then the equilibrium price will remain same, but the quantity will fall. If the fall in aggregate supply is greater than the fall in aggreate demand, then the equilibrium price will rise but the quantity will fall. On the other hand, if the fall in aggregate supply is lesser than the fall in aggreate demand, then the equilibrium price will fall but the equilibrium quantity will also fall.

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