Question

1. What does an aggregate demand curve represent?
2. What are the three reasons the aggregate demand curve is downward sloping?
3. What government policies can shift the aggregate demand curve?
4. What does the aggregate supply curve represent?
5. Why is the short-run aggregate supply curve different than the long-run aggregate supply curve?
6. When aggregate demand shifts to the right, what happens to price level, output, and unemployment in the short-run? (Note that employment is not explicitly shown on the AD/AS model but will generally move in the same direction as output.) Does your answer depend on whether the economy is currently in a recession or at its potential GDP?
7. When the short-run aggregate supply shifts to the right, what happens to price level, output, and unemployment?

Answer 1

What does an aggregate demand curve represent?

Aggregate demand curve represents demand for goods and services at difference prices.

What are the three reasons the aggregate demand curve is downward sloping?

Downward sloping demand reasons:

• Decrease in price raises the real balance, so people demand more goods and services.
• Interest rate effect - when there is fall in price, lesser money is required to make transactions. So when money demand falls, interest rate to decreases. Eventually, there is fall in interest rate. Fall in interest rate, raises investment level.
• Real Exchange rate- when price is down, interest rate is down, it causes outflow of capital. So domestic currency depreciates, depreciation of currency causes rise in export. So AD rises.

What government policies can shift the aggregate demand curve?

Government can shift AD by changing expenditure and taxes.

What does the aggregate supply curve represent?

AS denotes the different level of quantity supplied at different prices. Supply is positively related to the price level.

Why is the short-run aggregate supply curve different than the long-run aggregate supply curve?

Short supply curve is either horizontal or upward sloping suggesting availability of extra capacity. Thus output can be increased by pushing up aggregate demand. But Long run AS is vertical. Supply can not be increased beyond this point.

When aggregate demand shifts to the right, what happens to price level, output, and unemployment in the short-run? (Note that employment is not explicitly shown on the AD/AS model but will generally move in the same direction as output.) Does your answer depend on whether the economy is currently in a recession or at its potential GDP?

Rise in aggregate demand is effective in increasing output and employment level if economy is operating below the full potential level or output is less than potential level. Price also might rise marginally in this phase but if economy reaches full employment stage, the change in demand would be fully reflected on price level.

When the short-run aggregate supply shifts to the right, what happens to price level, output, and unemployment?

Shift in supply curve to right implies that output would be on rise, and unemployment rate will fall. Price is likely to fall.