Question

. Evaluate the effect of the following situations on the AD curve, AS curve, equilibrium price level, and equilibrium output in the U.S.

                (a) The U.S. imposes tariffs on foreign goods to promote domestic industry. In retaliation, foreign countries impose tariffs on U.S. goods.

                (b) Congress decides to decrease personal income taxes, and to compensate for the lost revenue they decrease business subsidies.

                (c) A technology boom improves technology across industries, improving their productivity.

(d) U.S. oil companies discover new large oil reserves in the U.S. The international price of oil falls.

   (e) Consumers expect a recession

(For supply and demand use shift left, right, or NC for No Change)                 

             Supply                        Demand                        

example:   right                          NC                                                                    

1.   _______                    _____________

2.    _______                    _____________   

3.    _______                    _____________

4.    _______                    _____________

5. _______    _____________

Answer 1

In each graph, initial equilibrium is at point A where AD0 (aggregate demand) and SRAS0 (short-run aggregate supply) curves intersect, with equilibrium price level P0 and real GDP (= Potential GDP) Y0.

(a)

Tariff on US goods will increase the prie of US-made goods abroad, decreasing US export demand. Net exports will fall, reducing aggregate demand. AD curve will shift to left, lowering price level and lowering real GDP.  In following graph, AD curve will shift leftward from AD0 to AD1, intersecting SRAS0 at point B with lower price level P1 and lower real GDP Y1.

(b)

Lower personal tax will increase consumption demand, and lower business subsidy will decrease investment demand. Since 65%-70% of aggregate demand is composed of consumption, the net effect will be an increase in aggregate demand. AD curve will shift to right, raising price level and raising real GDP.  In following graph, AD curve will shift rightward from AD0 to AD1, intersecting SRAS0 at point B with higher price level P1 and higher real GDP Y1.

(c)

Improved productivity will increase production, thus increasing aggregate supply. SRAS curve will shift to right, lowering price level and increasing real GDP. In following graph, SRAS curve will shift right from SRAS0 to SRAS1, intersecting AD0 at point B with lower price level P1 and higher real GDP Y1.

(d)

Lower oil price decreases cost of inputs, lowering cost of production. Firms will increase production and output, increasing aggregate supply. SRAS curve will shift to right, lowering price level and increasing real GDP. In following graph, SRAS curve will shift right from SRAS0 to SRAS1, intersecting AD0 at point B with lower price level P1 and higher real GDP Y1.

(e)

Consumers expecting a recession will expect a fall in future income, so will reduce consumption and lower aggregate demand. AD curve will shift to left, lowering price level and lowering real GDP.  In following graph, AD curve will shift leftward from AD0 to AD1, intersecting SRAS0 at point B with lower price level P1 and lower real GDP Y1.