Question

Draw your own graph by adding a new AS or AD curve to the graph above to illustrate the effect of each of the following conditions: a. The price of crude oil rises significantly. b. Spending on national defense doubles. c. The costs of imported goods increase. d. An improvement in technology raises labor productivity.

Answer 1

(a) The price of crude oil rises significantly.

When the price of crude oil rises significantly, it normally happens when there is a sudden shortage of supply of crude oil. Thus the Aggregate Supply curve would shift to the left, the equilibrium price would increase and the equilibrium quantity would decrease.

(b) Spending on national defense doubles.

The spending on national defense doubles meaning that the aggregate demand has increased, so the aggregate demand curve shifts to the right, the equilibrium price increases and the equilibrium quantity decreases than before.

(c) The costs of imported goods increase.

The cost of imported good can increase because of either increase in aggregate demand which leads to depreciation of the local currently or because of a shortage of supply of the imported goods. Normally, the cost of imported goods increase because of the increase in the aggregate demand of the local country, which is shown below in the diagram. The equilibrium price is rising and the equilibrium quantity is also increasing.

(d) An improvement in technology raises labor productivity.

When labor productivity rises, the aggregate supply increases in the economy because now with the same resources, the laborers can produce more number of goods and services. So, the aggregate supply curve shifts to the right and the equilibrium price decrease and the quantity supplied also increases.