Question

Use the AD/AS model to illustrate what happens to United States equilibrium GDP and the price level under the following scenarios.  Also state what happens to national income and unemployment.  Illustrate only short run fluctuations in real GDP.

1.Canada, the number one destination of U.S. exports, goes into recession.

2.Energy prices rise throughout the economy.

3.Wages fall throughout the economy.

4.Congress passes a law lowering the income tax.

5.Businesses become more optimistic and raise their forecast ROI.

Include a caption! Beside or below each graph, explain why you shifted the curve.

Answer 1

In each of the following 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.

Recession in Canada will decrease Canadian import demand that lowers US exports, which decreases aggregate demand, shifting AD curve leftward and decreasing both inflation and real GDP. Unemployment increases.

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

2.

Higher energy price increases production cost, which decreases aggregate supply. SRAS shifts left, increasing inflation and decreasing real GDP. Unemployment increases.

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

3.

Lower wage decreases production cost, which increases aggregate supply. SRAS shifts right, decreasing inflation and increasing real GDP. Unemployment decreases.

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

4.

Lower income tax increases consumption spending, which increases aggregate demand, shifting AD curve rightward and increasing both price level and real GDP. Unemployment decreases.

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

5.

Higher business optimism increases investment spending, which increases aggregate demand, shifting AD curve rightward and increasing both price level and real GDP. Unemployment decreases.

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