Question

. Describe the effects of each of the following events on the US economy (i.e. What may happen to the price? To the real output?). Explain briefly what cause these effects (i.e. What happens to determinants of AD or AS or both? Why? ).Ilustrate your answers in given AD-AS diagrams. Label your diagrams and changes carefully a) Potential middle-east war pushed the price of oil higher. AS AD b) Technology innovation results in a more efficient production method of goods. AS AD

Answer 1

In each graph, initial equilibrium is at point A where AD intersects AS with initial price level P0 and real output Y0.

(a) Higher price of oil will increase input cost, which will increase production cost for firms. So the firms will lower output and aggregate supply will fall. AS curve will shift leftward to AS1, intersecting AD at point B with higher price level P and lower real output Y1.

(b) Advanced production technique will decrease production cost for firms. So the firms will increase output and aggregate supply will rise. AS curve will shift rightward to AS1, intersecting AD at point B with lower price level P and higher real output Y1.

(c) Lower wealth will decrease consumption which will decrease aggregate demand. AD curve will shift leftward to AD1, intersecting AS at point B with lower price level P and lower real output Y1.