Question

1. Our economy is currently experiencing conditions that have not occurred in recent history. Using the AS/AD model developed in Chapter 10, explain how our current economic conditions impact aggregate supply and aggregate demand. There is no right or wrong answer, you just need to justify your answer thoroughly. Be sure to comment on AD, LRAS and SRAS curves including the shape of the SRAS curve and why.

2. Are there any economic indicators that can support your answer? Hint: use your FRED dashboard (other series could be used too) Don’t feel like this answer needs to be complicated or has to have a lot of info. If you find that no indicator supports your answer you could say that but you could say why you think that is the case, or you could only see one or two and that is ok. Don’t over think this one!

3. Graph the AS/AD you described in Question 1. Be sure to label all axes, curves and changes in equilibrium. Add arrows to indicate any shifts in curves. You can add your graph to the word document or include it as an additional attachment.

Answer 1

In aggregate demand and aggregate supply model, the aggregate demand is a downward sloping curve showing the total demand for goods and services in the economy at various price levels. The components of aggregate demand include the consumption expenditure, investment expenditure, government expenditure and net exports in an economy.

Similarly, Aggregate supply is an upward sloping curve showing the quantity of goods and services that the producers will supply in the market at various price levels. Short run AS is an upward sloping curve.

Now the equilibrium is determined in the economy where aggregate demand becomes equal to the aggregate supply.

Now this equilibrium changes when there are shocks to aggregate demand and aggregate supply in the economy.

For example, due to COVID-19, there is a lockdown in place. Due to this, people are not able to go out and shop, eat etc (except groceries). Also, no new investments are happening and exports have also been significantly affected. This has shifted the aggregate demand curve leftwards.

Also, aggregate supply will also shifted backwards in the economy. This is because of shut down of production units due to lockdowns in place and no new investments happening due to piling up of inventories.

Now, these shocks and their impact is shown in the accompanying image. Here, we have assumed the level of shock to both AD and AS to be equal in magnitude. Due to this, the price level has stayed the same. However, the equilibrium quantity has declined. We have also assumed that at the initial equilibrium level of output, we were at full employment level or the potential GDP was equal to the actual GDP.

We have also shown a long run AS curve in the diagram. LRAS shows the potential level of output in the economy.

When we move away from this potential level of output, unemployment will increase because we are no longer operating at the full employment level.

The level of unemployment is a useful indicator here that was asked in the question. For example, the number of workers out of work have increased significantly. This has contributed to unemployment. This has shifted AS backwards and there is an output gap in the economy between actual GDP and potential level of GDP.