Question

Draw and carefully describe a graph that utilizes the Aggregate Demand/Aggregate Supply model that would illustrate the current state of the aggregate economy in the United States as of July 2020. The graph should be clearly labeled and explained in some detail. Include an aggregate demand curve, a short run aggregate supply curve, and a long run aggregate supply curve (LRAS/Potential GDP). Label both axes of the graph. Identify the current price level using the GDP deflator on the verticle axis and the level of real GDP on the horizontal axis (from July 2020).

Answer 1

Figure-1 in the document attached below illustrates a comparison between the condition of the goods market in the US in January 2020 and that of in July 2020 or up until the current time. The price level of goods and services in the goods market or P and the real output or income level in the goods market or US economy or Y are represented in the y and x axis in figure-1 respectively. The AD, SRAS and LRAS curves in the figure denote the aggregate demand, short-run aggregate supply, and long-run aggregate supply curves in the US goods market with AD1, SRAS1, and LRAS1 representing the aggregate demand curve, short-run aggregate supply curve, and long-run aggregate supply curve during the beginning of the year or January 2020. Now, mainly due to the global outbreak of COVID-19 pandemic, a comprehensive temporary economic inactivity or lockdown as a preventive measure against the detriments of the viral contagion has essentially led to a short-term decrease in the overall production level of goods and services by most of the domestic firms or companies. Such a temporary negative supply shock in the US economy has consequently led to a reduction in the SRAS in the US goods market as indicated by a leftward or upward shift of the SRAS curve from SRAS1 to SRAS2 until the present time or mid-July 2020 accompanied by a widespread reduction in productive resource or factor/input utilization or mobilization by the domestic firms or companies used in the production of goods and services. It essentially implies an expansion in the unemployment level in the domestic economy and higher rates of joblessness. Now, furthermore, a decline in the aggregate investment expenditure due to the temporary economic inactivity or lockdown and aggregate consumption expenditure or spending on various goods and services such as restaurant dining, airlines services, electricity consumption, consumption of durable luxury goods such as cars or electronic appliances, etc. following the pandemic outbreak have also led to the reduction in the AD which is shown by a leftward or downward shift of the AD curve from AD1 in Januray 2020 to AD2 at the present time. Therefore, a simultaneous decline in both SRAS and AD has caused a decrease in the real output or income in the US goods market or the economy from Y*1 in the beginning of the year to Y*2 up until the current time but however the price level of goods and services in the goods market or the economy remains stable at its original or initial position at P*1 as both SRAS and AD have declined at the same time thereby adjusting P accordingly. Note that in figure-1 the difference between Y*1 corresponding to the intersection of LRAS1, SRAS1, and AD in the beginning of the year and the Y*2 in July 2020 represents the negative output gap implying that the estimated or predicted level of real output or income is higher than the actual level of real income or output in the US goods market or economy due to the economic repurcussions of the COVID-19 pandemic.