Question

12.AGGREGATE DEMAND AND AGGREGATE SUPPLY

a. What is the economic reason why the SRAS curve slopes up?

b. Name some factors that could cause AD to shift, and say whether they would shift AD to the right or to the left.

c. Would a shift of AD to the right tend to make the equilibrium quantity and price level higher or lower? What about a shift of AD to the left?

d. Suppose concerns about thesize of the federal budget deficit lead the U.S. Congress to cut all funding for research and development for ten years. Assuming this has an impact on technology growth, what does the AD/AS model predict would be the likely effect on equilibrium GDP and the price level?

e. Suppose Mexico, one of our largest trading partners and purchaser of a large quantity of our exports, goes into a recession. Use the AD/AS model to determine the likely impact on our equilibrium GDP and price level.

f. What impact would decrease in the size of the labor force have on GDP and the price level according to the AD/AS model?

g. Suppose the Federal Reserve increases the supply of money. What impact would that have on GDP, unemployment, and inflation?

Note: these questions are based on OpenStack, Chapter 11(link on Canvas). You are recommended to draw the relevant AD & AS graph to accompany each answer.

Answer 1

(a) The short Run Aggregate Supply curve slopes upward because its is ofdrawn on the assumption of a Iffixed expected price level. If the price level in the economy changes, the workers as well as the producers are unable to interpret if it is a real or a nominal change. Hence, in response to a rise in prices, they tend to produce more (thinking that the prices of their product have increased) and similarly, tey tend to produce less in response to a lower peice level.

b) Factors shifting AD:

i) Change in Money Supply: Increase in money supply shifts it rightwards while a decrease will shift it leftwards

ii) change in autonomous investment: Increase shifts AD rightwards and decrease shift AD leftwards.

C) Rightward shift in AD represents an increase in Demand for output corresponding to each price level. Hence, it tends to increase the prices and quantity.

Leftwards shift in AD represents a fall in Demand for output corresponding to each price level. Hence, it leads to a fall in both prices and quantity.

However, If the Aggregate Supply curve is vertical i.e. LRAS, only price level changes and quantity remains the same.

D) The decrease in funding of R&D will lead to a fall in the grow rate of technology and productivity in the future years. This is expected to slow down the rate of growth of GDP in the future periods. The supply curve would shift by relatively lesser amount then it would have been with earlier rate of growth of technology.

Also, the Aggregate Demand is expected to expand due to higher budgetary deficits which tends to increase both the GDO and Price level.

However, the exact effect on quantity and prices would depend on the relative strength of changes in Aggregate demand and output. But both the aggregate output and price level are expected to rise in the future.