Question

b. What is the relationship between price level and total output in an AD - AS model?

Answer 1

AD AS model consists of Aggregate demand and Aggregate supply curves.

There is negative relationship between price level and total output level in Aggregate demand curve. Aggregate demand means the total spending in the economy (consumption spending + investment spending + government spending). We know that at higher price levels aggregate spending in the economy will decrease. Similarily, at lower price levels the aggregate spending in the economy will increase. This shows a negative relationship between total output and price level.

There is a positive relationship between price level and total output level in short run aggregate supply curve. Aggregate supply curve represents the total output of goods and services that firm produces at each possible price level. When the price level is high , firms will produce more in the hope of gaining more. When price level in the economy is low, firms will produce less for preventing them from losses. Thus there is a positive relationship between price level and total output level in aggregate supply curve.