Question

• Describe how the aggregate demand/aggregate supply model interact at the macroeconomic level.
• Explain how productivity growth and changes in input prices change the aggregate supply curve.
• Identify influences on aggregate demand.
• Explain how the aggregate demand/aggregate supply model incorporates growth, unemployment, and inflation.

Answer 1

AD is downward sloping and AS is upward sloping. Together they determine the level of output in the short run and the price level in the economy.

AS is affected by the labor productivity and input prices. If input prices are increased, this will increase production cost and reduce output. This should shift AS to the left. Similarly, when input prices are decreased, AS shifts right. Increased labor productivity shifts AS to the right because more can be produced with same resources.

AD is influenced by its components, namely consumption, investment, government spending, exports and imports. It is also affected by taxes and rate of interest, as well as optimism in the market

AD-AS model can result in increased unemployment when the short run output falls short of the potential output. At the same time there is a reduction in inflation rate. Likewise, AD-AS model can result in decreased unemployment when the short run output exceeds potential output. At the same time there is an increased inflation. Growth occurs when output is increased.