Question

AS & AD Practice Set

1.Draw five aggregate supply and demand graphs atlong run equilibrium. Illustrate what would happen to the price level, output and employmentunder the following circumstances:

a.Congress raisestax ratesto fight the growing deficit.

b.Businesses growing more depressed about future earnings.

c.Energyprices rise dramatically across the US.

d.Demand-pull inflation sets in.

e.Economies of Canada and Mexico (two of our biggest trading partners) fall into recession.

Answer 1

a). When there is a rise in the tax , the disposable income of the people would fall. The disposable income is the income that is left after the taxtation , so a rise in the taxes obviously decreases the disposable income and there by decrease the consumption expenditure. Since the consumption is a component of the aggregate demand , the aggregate demand will decrease , this is shown by a leftward shif of the AD cuve. As a result of the decrease in AD , the price level and the real GDP will fall.

b). If business feel pessmistic about the future opportunities, they probably would cut the investment expenditiure and lay off the workers. The unemployment would increase and this would lead to a decrease in the income, this will negatively affect the aggregate demand. The aggregate demand would decrease so the price and the real GDP would fall.

c). The electricity is major input for business , so an increase in the energy prices adds to the business costs. The firms would cut the production to compensate the increased cost, the supply will decrease and the SRAS curve will shift to the left. The equilibrium price level rises and the Real GDP decrease.

4). The demand pull inflation results from an increase in the aggregate demand , this is shown by a rightward shift of the AD curve. The price level and the real GDP will increase.

5).

The recession in the trading countries will adversly affect the net exports of the home country , so the aggregate demand will decrease. This is shown below, the price level and the real GDP falls.