Question

Explain how each of the following affects the aggregate supply and/or aggregate demand curve and equilibrium GDP and prices in the short and long run. Does your answer depend on where the economy is in terms of full employment when the change happens?

Consumer spending increases

Investment spending increases

Government spending is reduced

US exports fall

Tax rates are lowered

Raw material (e.g., energy) prices rise

Wages increase

Answer 1

1. Increase in Consumer spending shifts AD curve rightwards as C is th component of AD. It leads to increase in equilibrium price and quantity.

2. Increase in Investment spending means increase in I component of AD. This shifts AD curve rightwards and increases equilibrium price and quantity.

3. Decrease in Government spending means G component of AD decreases. It leads to leftward shift of AD curve and causes decrease in equilibrium price and quantity.

4. AD = C + I + G + X - M

X is the exports. Increase in exports leads to increase in AD and thus causes rightward shift of AD.

5. Lower tax rate means firms cost decreases which increases supply of commodity in the market. This causes rightward shift of AS curve. It causes increase in equilibrium GDP and decreases price.

6. When price of raw material rises then production of good become expensive so supply of commodity falls. This causes leftward shift of AS curve. It leads to increase in equilibrium price and decrease in equilibrium quantity.

7. Increase in wage means expenditure of firm increases. Production of good decreases and this shifts AS leftwards. Increases equilibrium price and decreases real GDP.