Question

Assume a model with a Keynesian downward-sloping aggregate demand curve and an ordinary upward -sloping aggregate supply curve. Using this model please show the effects on the following events on separate graphs and explain

A.an increase in import spending

b.an increase in resource prices

c.an decrease om the value of the dollar

d.an increase in sales taxes

e. an increase in capacity utilization

Answer 1

In following graphs, 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 (which equals Potential GDP) Y0.

(A)

Higher import spending decreases net exports, which decreases aggregate demand, shifting AD curve leftward and lowering both price level and 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)

Higher resource prices will increase production cost, so firms will decrease production, decreasing aggregate supply. SRAS curve will shift to left, increasing price level and decreasing real GDP. In following graph, SRAS curve will shift left from SRAS0 to SRAS1, intersecting AD0 at point B with higher price level P1 and lower real GDP Y1.

(C)

Decrease in dollar will decrease import demand and increase export demand, increasing net exports. This raises aggregate demand, shifting AD curve rightward and increasing both price level and 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.

(D)

Increase in sale tax will increase the cost of business, so firms will decrease production, decreasing aggregate supply. SRAS curve will shift to left, increasing price level and decreasing real GDP. In following graph, SRAS curve will shift left from SRAS0 to SRAS1, intersecting AD0 at point B with higher price level P1 and lower real GDP Y1.

(E)

Increase in capacity utilization will make firms increase production, increasing aggregate supply. SRAS curve will shift to right, decreasing 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.