Question

A..--- What causes changes in total spending in an economy? Summarize in your own words. ( GO THROUGH ALL THE COMPONENTS IN GPA)

​How will each of the following likely change the aggregate supply curve? Why?

1*An increase in the labor force?

2*An increase in capital?

3*An increase in cost of raw materials?

4*A reduction in the costs created by regulations?

5*Compare the effects of increase in unemployment with the decrease in the labor force. (Be careful here.)

Answer 1

(A)

GDP (Y) = C + I + G + X - M

Therefore, total spending (Y) will increase if one or more of the following increases: Consumption (C), Investment (I), Government spending (G) or Exports (X), or import (M) decreases (if taxes decrease, disposable income increases, which will increase consumption).

Total spending (Y) will decrease if one or more of the following decreases: Consumption (C), Investment (I), Government spending (G) or Exports (X), or import (M) increases (if taxes increase, disposable income decreases, which will decrease consumption).

(B)

(1) Increase in labor force increases resources of production, which increases both short-run aggregate supply (SRAS) and long run aggregate supply (LRAS).

(2) Increase in capital increases resources of production, which increases both SRAS and LRAS.

(3) Increase in cost of raw materials increases input costs, which decreases SRAS, leaving LRAS unchanged.

(4) Reduction in costs lower production and business expenses, which increases SRAS, leaving LRAS unchanged.

(5) Increased unemployment lowers disposable income, reducing consumption which lowers aggregate demand. AD curve shifts leftward, lowering both price level and real GDP. A decrease in labor force decreases both SRAS and LRAS, shifting both curve leftward, increasing price level and decreasing real GDP. Therefore in new short-run equilibrium, real GDP will definitely decrease. But effect on price level is uncertain.