Question

Macro economics

2) The AS AD model
a. What macroeconomic variables does this model seek to explain?
b. What would cause the AD curve to shift? (same as 1c, above)
c. What would cause the AS curve to shift? (same as 1f, above)
d. What are the macroeconomic outcomes from each shift in each curve?

Answer 1

a) AD-AS model seeks to explain the changes in price level and output which is explained by shifts in the aggregate demand and aggregate supply. Aggregate demand is the demand for the whole economy that includes households, businesses, government etc while aggregate supply is the supply of goods by suppliers at different price levels. Their interaction leads to determination of price level and equilibrium output in the economy.

b) AD would shift when there is a change in any of its components like AD =C+I+G+N-X where C is consumption, I is investment G is government spending and N-X is net exports. Any other than these would be expectations of consumers, exchange rate etc.

c) AS curve represents the quantity of good which is supplied by suppliers at different levels. This is determined by the prices of goods, cost of raw materials, taxes, transportation costs , government subsidies etc.

d) When the aggregate demand component increase, the curve shifts to right, increasing both the equilibrium price levels and equilibrium quantity. On the other hand a decrease in these components like reduction in consumption or increased taxes etc would shift it to left and the price level and equilibrium quantity decreases. The former implies that people are demanding more and hence higher production etc while latter means there is pessimism and people are demanding less.

On the other hand aggregate supply curve would shift to right when there is technological advancements, decreased raw material prices, increased subsidies etc, which would reduce equilibrium price but increase equilibrium quantity. On the other hand, increased transportation costs, high levels of prices of raw material would reduce the supply, shifting the curve to left.

(You can comment for doubts)