Question

1. What factors shift the AD curve? What factors shift the AS curves?

2. Use the Income-Expenditure Model(I-E) and the AD-AS Model to determine the size and direction of any shifts that occur in the AEp line, rGDP demanded, and the AD curve for the following changes in spending (MPC=.9). Show all work, and illustrate your results graphically. a. $8 billion increase in investment spending. b. $5 billion decrease in government spending. c. $20 billion increase in autonomous consumption spending.

3. Using the AD-AS model, illustrate graphically and explain what occurs in the short run if there is an increase investment spending of $60 billion (MPS=.2). How does the economy adjust to long run equilibrium? Hint: Begin in short run and long run equilibrium.

Label the graph and the axes accordingly and please be neat.

Answer 1

1. Factors that shift the aggregate demand curve:

A) Change in expectations : If firms and consumers become optimistic about the future, consumption spending and investment increase. Therefore, Aggregate demand increases, shifting the AD curve rightward.

If firms and households become more pessimistic, AD curve shifts leftward.

B) Fiscal policy and monetary policy : Expansionary fiscal policy and expansionary monetary policy increase aggregate demand, shifting the AD curve rightward.

Contractionary fiscal and monetary policy decreases aggregate demand, shifting the AD curve leftward.

C) Changes in wealth : If the real value of household assets increases, AD increases, shifting the AD curve rightward.

If the real value of household assets decreases, AD shifts leftward.

Factors that shift the aggregate supply curve:

A) change in input prices: increase in input prices increases cost of production. This will decrease the aggregate supply, shifting the AS curve leftward.

Decrease in input prices shifts the AS curve rightward.

B) Productivity: When workers become more productive, AS increases. AS curve shifts rightward. When workers become less productive, AS shifts leftward.

C) change in nominal wages: when nominal wages fall, AS shifts rightward. When nominal wages rise, AS shifts leftward.