1. Aggregate Demand and Aggregate Supply
A typical aggregate supply curve has three parts: a flat, horizontal portion at low levels of output, a middle section with a more-or-less gentle upward slope, and a steep or vertical portion at high levels of production. Let's consider two of these parts individually, the horizontal portion and the vertical portion.
A. Imagine that aggregate demand and supply intersect in the horizontal portion of the AS curve. Assume a technological breakthrough increases the full-employment level of RGDP and shifts in aggregate supply to the right. In this case, when aggregate supply increases, how does the output of the economy change? Does supply create its own demand?
When aggregate supply increases, it means that the amount of goods and services in an economy increases and also shows how much output is supplied by firms at different prices. When aggregate supply increases, there is a growth in output and a decrease in GDP at any given prices. Supply creates its own demand in such a way creation of product and services without the equal flow of demand for those goods is not possible.
B. Imagine that AS and AD intersect in the horizontal portion of the AS curve. In this case, if aggregate demand increases, how does the output of the economy change? Does demand drive the economy here?
When there is an increase in the aggregate demand, the firms within an economy work towards meeting these demands by increasing the current productions, in this case, there is little or no change to the level of prices. Their demand will, of course, drive the economy because it is in the Keynesian portion of the graph and there is a great change in the level of output.
C. Imagine that AS and AD intersect in the vertical portion of the AS curve. In this case, if aggregate demand increases, how does the output of the economy change? Does demand drive the economy here?
The intersection point is called the equilibrium point; this point determines the amount of output produced in any given economy with a given set of prices in a given period. When there is an increase in demand, the prices of commodities also increase since the demand is high. At this stage, the economy also is assumed to be at an equilibrium level.
D. Imagine that AS and AD intersect in the vertical portion of the AS curve. Assume a technological breakthrough increases the full-employment level of RGDP and shifts the AS curve to the right. In this case, when aggregate supply increases, how does the output of the economy change? Does supply create its demand?
Technology affects the aggregate supply since, at this point, everything within an economy is assumed to be utilized at equilibrium. The output of the economy will not have a substantial change, but prices of various commodities might decrease since the supply curve will shift to the right. In this case, supply does not create demand
E. Which part of the AS curve is consistent with the Keynesian model, and which part of the AS curve is in conformity with the classical model?
The part which is consistent with the Keynesian model is curved with an upward slope and the part which is in line with the classical model is the vertical part.
2. Aggregate Expenditure Model
Aggregate expenditure equals the sum of consumption, investment, government spending, and net exports. These are also the components of aggregate demand. The aggregate expenditure model looks at the effects of changes in demand on income (Y), assuming that the price level does not change. Likewise, in the flat or Keynesian portion of the AS curve, the price level will not change when output changes.
A. In an AE model with MPC = 0.80, the government increases spending by $100 million. What will be the increase in equilibrium Y in the Keynesian AE model?
In an AE model with MPC equals 0.80, the increase in government expenditure will lead to increase in Y.
Aggregate expenditure formula will be:
1 / 1-MPC 1-MPC is 1-0.80,
So the denominator of the formula for the multiplier is 0.20.
Now divide one by 0.20, the multiplier is 5.
To find out how much the equilibrium changes, we multiply the multiplier by the change in investment. Since investments rose by $100 (100 * 5) Therefore, increase in Y will be $500
B. Say you have two graphs of an economy: a graph showing the Keynesian model (as discussed in part A, above) and another showing the AD/AS model. In the AD/AS diagram, the shifts in aggregate demand to the right by the amount of the increase in Y predicted by the Keynesian AE model. If the aggregate demand curve intersects the aggregate supply curve in the flat, Keynesian portion of the AS curve, what will be the increase in real output in the AD/AS model resulting from the $100 million increase in government spending?
The intersection of aggregate demand and aggregate curves indicates an equilibrium price, and this means that the prices will not increment in any way. As a result, this will lead to the optimum multiplier effect of the increase in the fiscal year. Since the prices remain even with the increase in government spending, there will be no crowding of fiscal development
C. Continuing the line of questioning from part B, above, now say the AD curve intersects the AS curve where the AS is vertical. What will be the increase in real output in the AD/AS model resulting from the $100 million increase in government spending?
At this particular time, the equilibrium is held at the vertical part of the aggregate demand curve, as such when the government increases its spending results to increase in price alone while the GDP remains. In his case, when the government spends $100 more, there is no change in the GDP but prices only.
D. If the AD curve intersects the AS curve in the middle section of the AS curve, can you calculate the increase in real output in the AD/AS model resulting from the $100 million increase in government spending? If not, what additional information would you need?
When the aggregate demand intersects the aggregate supply it means that the economy is at equilibrium. When the government increases its spending by $100, more goods and services are brought into the economy. The government spending is attributed to increased demand and in this case, there is the partial increase in prices, and price increase leads to change in interest rates, and this impacts the level of investment. As a result, if this, any increment in Y relays upon the investment function plus other components affecting multiplier effect.
E.In general, what effect does the slope of the AS curve have on the size of the change in real output due to an increase in autonomous expenditure in the AE model?
In the long run aggregate supply curve, the shift in aggregate supply curve depends on the factors of production change. In this case, the curve only shifts when there is a decrease or increase in output. In the short run aggregate supply, the quantity supplied leads to increase in prices. When there is an increase in prices, the demand is low hence the output decreases.
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