Question

1. Aggregate Demand curves slope down. Explain in a sentence what that means (what happens when Price Level falls, all else constant?) and give one reason for the negative slope (inverse relation).

2. Assume an economy operates in the intermediate range of its aggregate supply curve. State the direction of shift for the aggregate demand curve or aggregate supply curve for each of the following changes in conditions. What is the effect on the price level? On real GDP? On employment?

a. The price of crude oil rises significantly (300%, say) raising the price of energy generally.

b. Spending on national defense doubles.

c. Investment spending falls as firms expect slower sales growth.

d. An improvement in technology raises labor productivity.

e. The United States raises exports of new passenger aircraft to China.

3. Identify the three ranges of the aggregate supply curve. Explain the impact of an increase in aggregate demand in each range.

Answer 1

Answer 1 - The downward slope of AD also called the negative slope denotes that the price level in the economy and the demand for goods and services is inversely related to each other.

This is because , as price falls , the real income and purchasing power rises , hence more goods are demanded. When price rises , real income and purchasing power drops leading to lesser AD. This is why AD curve is downward sloping.

2a - AS will fall , AS curve will shift left , Price level and unemployment will rise , GDP will fall.

B - AD will rise and AD curve will shift to right. Price level will rise , unemployment will fall and GDP will rise.

C - AD will fall , AD will shift left , Price level and GDP will fall , unemployment will rise.

D - AS will rise , AS will shift right. Price level will fall , unemployment will fall , GDP will rise.

E - AD will rise. AD will shift right , Price level and GDP will rise , Unemployment will fall.