Question

Use the Aggregate Demand and Aggregate Supply model to analyze the impacts of the following events, show this on a graph for each situation.

1) Steelworkers go on strike and produce less steel.

2) US Senators read about the glories of the Internet and so demand for high tech government purchases increases.

3) A series of Investment Banks such as Lehman Bros and Bear Sterns go bankrupt,

Answer 1

In all graphs, initial equilibrium is at point A where AD0 (aggregate demand) and SRAS0 (short-run aggregate supply) curves intersect with initial equilibrium price level P0 and initial equilibrium real GDP Y0.

(1)

Production of less steel decreases aggregate supply. SRAS shifts left, increasing price level and decreasing real GDP.

In following graph, SRAS0 shifts to SRAS1, intersecting AD0 at point B with higher price level P1 and lower real GDP Y1.

(2)

Increase in government purchase increases aggregate demand, shifting AD curve rightward and increasing both price level and real GDP.

In following graph, AD0 shifts rightward to AD1, intersecting SRAS0 at point B with higher price level P1 and higher real GDP Y1.

(3)

Investment banks going bankrupt decreases investor confidence, which decreases aggregate demand, shifting AD curve leftward and decreasing both price level and real GDP.

In following graph, AD0 shifts leftward to AD1, intersecting SRAS0 at point B with lower price level P1 and lower real GDP Y1.