Question

Draw a graph of an aggregate demand shock using the AS-AD diagram. Make sure to label the axes correctly as well as show the impact of the shock on output, inflation and unemployment.

Answer 1

1. Demand shocks

   AD equation, whereas a sudden change in the exchange rate is an exogenous shock because exchange rates are not directly included in the AD equation.

   A number of demand side shocks can directly affect planned spending in the economy. These include:

   1)Shocks affecting household or corporate spending, such as changes inunemployment, savings, confidence, wages, and profits. 2)Shocks associated with changes inliquidity and the availability of consumer and business credit, as in the recent credit crunch. 3)Changes in spending associated with changes in house prices, share and bond prices, called wealth effects. 4)Shocks affecting investment spending, including changes in bankruptcies, business confidence, and profit levels. 5)Changes in government finances, brought about by wars, and changes in unemployment. 6)Shocks directly affecting exports orimports, such as the economic collapse of a trading partner. 7)Other demand side shocks affect planned spending indirectly, such as changes in:

2. *Interest rates, which affect both consumer and investment spending.

   *Tax rates, which also affect consumer and investment spending.

   *Exchange rates, which affect exports and imports.   Changes in any of the above will shift the position of the AD curve

   1. Shifts in AD

      An increase in AD, such as that caused by an increase in household spending, is shown by a rightward shift in the whole AD curve.

      The shift in demand will have an effect on the price level and national output, but the effects may not be uniform because aggregate supply (AS) may not be linEar.