Question

Illustrate the following event with an AS or AD shift:

a. Government cuts defense spending.

Instructions: Grab either the AD or AS curve and drag-and-drop it in a new position to represent the resulting shift in AD or AS.  

  

b. Interest rates rise.

Instructions: Grab either the AD or AS curve and drag-and-drop it in a new position to represent the resulting shift in AD or AS.  

  

c. Imported oil gets cheaper.

Instructions: Grab either the AD or AS curve and drag-and-drop it in a new position to represent the resulting shift in AD or AS.  

  

d. Taxes on the rich are increased.

Instructions: Grab either the AD or AS curve and drag-and-drop it in a new position to represent the resulting shift in AD or AS.  

  

e. Consumer confidence increases.

Instructions: Grab either the AD or AS curve and drag-and-drop it in a new position to represent the resulting shift in AD or AS.

f. Taxes on consumers are cut.

Instructions: Grab either the AD or AS curve and drag-and-drop it in a new position to represent the resulting shift in AD or AS.

g. Oil becomes much more expensive.

Instructions: Grab either the AD or AS curve and drag-and-drop it in a new position to represent the resulting shift in AD or AS.

h. Interest rates fall.

Instructions: Grab either the AD or AS curve and drag-and-drop it in a new position to represent the resulting shift in AD or AS.

Answer 1

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

(a)

Lower defense spending lowers government expenditure, which decreases aggregate demand, which will shift the AD curve to left, which decreases both price level (decreasing inflation) and real GDP in short run.

In following graph, decrease in aggregate demand shifts AD0 to left to AD1, intersecting SRAS0 at point B with lower price level P1 and lower real GDP Y1.

(b)

Higher interest rate lowers investment spending, which decreases aggregate demand, which will shift the AD curve to left, which decreases both price level (decreasing inflation) and real GDP in short run.

In following graph, decrease in aggregate demand shifts AD0 to left to AD1, intersecting SRAS0 at point B with lower price level P1 and lower real GDP Y1.

(c)

Cheaper oil price will lower production cost, which will increase aggregate supply, shifting SRAS curve rightward, decreasing price level and increasing real GDP in short run.

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

(d)

Higher tax lowers disposable income and consumption spending, which decreases aggregate demand, which will shift the AD curve to left, which decreases both price level (decreasing inflation) and real GDP in short run.

In following graph, decrease in aggregate demand shifts AD0 to left to AD1, intersecting SRAS0 at point B with lower price level P1 and lower real GDP Y1.

(e)

Higher consumer confidence increases consumption, which increases aggregate demand, which will shift the AD curve to right, which increases both price level (increasing inflation) and real GDP in short run.

In following graph, increase in aggregate demand shifts AD0 to right to AD1, intersecting SRAS0 at point B with higher price level P1 and higher real GDP Y1.

(f)

A tax cut increases disposable income and consumption, which increases aggregate demand, which will shift the AD curve to right, which increases both price level (increasing inflation) and real GDP in short run.

In following graph, increase in aggregate demand shifts AD0 to right to AD1, intersecting SRAS0 at point B with higher price level P1 and higher real GDP Y1.

(g)

Higher oil price increases production cost, which will reduce aggregate supply, shifting SRAS curve leftward, increasing price level and decreasing real GDP, causing stagflation in short run.

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

(h)

Lower interest rate raises investment, which increases aggregate demand, which will shift the AD curve to right, which increases both price level (increasing inflation) and real GDP in short run.

In following graph, increase in aggregate demand shifts AD0 to right to AD1, intersecting SRAS0 at point B with higher price level P1 and higher real GDP Y1.