Question

How would each of the following affect the AD, the short run AS and the long run AS curves? Make sure to state why AD, short run AS and long run AS is effected or why it is not

1. An increase in money supply.
2. A slow down in China’s economic growth due to the sub-prime crisis in the US.
3. An increase in private and public capital investment.
4. A cut in income tax.

Answer 1

(a)

Increase in money supply will lower interest rates, increasing investment and increasing aggregate demand. AD curve will shift rightward. But investment being a demand-side factor, SRAS and LRAS will not be impacted.

(b)

Slow-down in economic growth will decrease aggregate demand, shifting AD curve leftward. Also, production by firms will decrease (in short run) since they do not have sufficient demand. So SRAS curve will shift leftward. But LRAS will not change, since LRAS is impacted by factors which affect the productive capacity in the economy.

(c)

Increase in capital investment will increase firms' production, so aggregate supply will rise, shifting SRAS curve rightward. Also, higher capital investment will increase capital stock, increasing the productive capacity. Potential output will rise, shifting LRAS curve rightward. However, increase in capital investment will not impact AD.

(d)

A cut in income tax will increase consumption (if it is personal income tax) or increase investment (if it is corporate income tax). Either of these effects will increase aggregate demand. AD curve will shift rightward. But consumption or investment being a demand-side factor, SRAS and LRAS will not be impacted.