Question

Draw the aggregate demand and aggregate supply graphs in a three-panel model: In the first graph, show aggregate demand on the graph and aggregate supply in the immediate short run. In the second graph, again show aggregate demand, but this time show aggregate supply in the short run. Finally, in the last panel, show aggregate demand and aggregate supply in the long-run. Be sure to label each axis and each curve in each graph

Discuss the following by referring to your graphs: 1) What are the determinants of aggregate demand and aggregate supply? 2) Why do the aggregate demand, aggregate supply (immediate short run), aggregate supply (short run), and aggregate supply (long-run) curves slope the way they do? Finally answer the question: What is the overall point that the graph model explains.

Answer 1

In the immediate short run the supply curve is horizontal because both input and output prices remain fixed.The short run staes that in a certain period in the future ,one input is fixed while others are variables.The short run AS curve is upward sloping. In the long run ,the aggregate supply curve is vertical at the economy's potential level of output.It is vertical which means  that in the long run total output in the economy will change temporarily with change in demand .Long run is a period when the economy at natural level of  employment,price flexibility and market adjustment. In the long run aggregate supply is affected only by capital, labor and technology as the assumption, that everything is used optimally holds.

1)The determinants of aggregate demand are consumption expenditures, investment expenditures,government purchases and net exports ie  AD=C+I+G+NX.The determinants of aggregate supply are size of the labor force,input prices,technology , productivity , government regulations , taxes and subsidies, capital etc.If the labor force increases , AS will shift to the right and vice versa.Again if the prices of inputs fall , aggregate supply will increase.Improvement in technology causes aggrgate supply to increase.When productivity increases , AS shifts to the right and vice versa.With more government regulation, AS shifts to the left and vice versa.A tax results in the upward shift of the aggregate supply curve as price increases and the subsidy results in downward shift of the aggregate supply curve as price decreases.

2)In the immediate short run the supply curve is horizontal because both input and output prices remain fixed.The short run staes that in a certain period in the future ,one input is fixed while others are variables.The short run AS curve is upward sloping. In the long run ,the aggregate supply curve is vertical at the economy's potential level of output.It is vertical which means  that in the long run total output in the economy will change temporarily with change in demand .Long run is a period when the economy at natural level of  employment,price flexibility and market adjustment. In the long run aggregate supply is affected only by capital, labor and technology as the assumption, that everything is used optimally holds.

The aggregate demand and aggrgate supply graph model shows what determines total demand and total supply in the economy and  interaction of total demand and total supply in the macro economic level.