Question

Question 3.

Explain the effects of the following events on Aggregate Demand or Aggregate Supply curves (AD/ SAS decreases or increases) - Specify the shift in AD/SAS curve and indicate what happens to the equilibrium price level and RGDP

(a). An increase in Government Spending

(b). Political conflicts leading business owners to become pessimistic about business's profitability

(c). An earthquake was large enough to cause a cut back in the supply of fuel

(d). A 5% tax is placed on the prices of several raw materials

Answer 1

a.

Effect: AD would increase. It shifts the AD curve towards right, makes equilibrium at higher point where both price level and RGDP would increase.

Explanation: An increasing government spending increases money supply in the economy; the consumption would increase, which increases AD and therefore, there is a shifting. Since there is no change in SAS curve, a shift of AD increases the price level by an increase in RGDP.

b.

Effect: this reduces the short-run aggregate supply (SAS). This curve would shift toward left, making equilibrium at a point where price increases but RGDP decreases.

Explanation: since suppliers have pessimistic thinking, their current supply would be low. This is the cause of shifting of SAS curve to the left. Since there is no change in AD, the equilibrium would be established at a higher point, where price level increases but RGDP decreases.

c.

Effect: this reduces the short-run aggregate supply (SAS). This curve would shift toward left, making equilibrium at a point where price increases but RGDP decreases.

Explanation: fuel is an input of production and supply; since its supply reduces, its price would increase. This increases input cost and therefore, decreases SAS by a shifting to the left. Since there is no change in AD, the equilibrium would be established at a higher point, where price level increases but RGDP decreases.

d.

Effect: this reduces the short-run aggregate supply (SAS). This curve would shift toward left, making equilibrium at a point where price increases but RGDP decreases.

Explanation: raw material is an input of production; since it is taxed, its price would increase. This increases input cost and therefore, decreases SAS by a shifting to the left. Since there is no change in AD, the equilibrium would be established at a higher point, where price level increases but RGDP decreases.