Question

Given a downward-sloping aggregate demand (AD) curve and an upward-sloping short-run aggregate supply curve (SRAS), equilibrium occurs where the two intersect. The value on the vertical axis is the equilibrium price level and the value on the horizontal axis is the equilibrium value of real GDP or output. What happens to the economy when AD shifts?

It is useful to sketch a graph and show the shift. Suppose, for example, interest rates fall or wealth increases due to a stock market boom, causing AD to shift to the right. The new equilibrium values indicate that these events will cause higher prices (inflation) and increased output. When output is increasing economy-wide, employment is also increasing, so this also means a lower unemployment rate. Does this analysis imply a trade-off between the rate of inflation and the rate of unemployment?

Minimum 75 words.

Answer 1

In economics GDP is said to be equal to consumption+investment+government expenditure+net exports but government expenditure and net exports is often excluded from the model to make it a simple and closed economy where aggregate demand in the economy could be increased or decreased o ly by changing the consumption and investment volumes.

In the given example, it is asked that what happens to the equilibrium price and equilibrium quantity when the AD curve shifts. This shift can be rightward or leftward implying increase in AD and decrease in AD respectively. The following given figure explains the shift of changes in AD and its effects on equilibrium price and equilibrium quantity. The picture has been attached for this part.

About the trade-off between the rare of inflation and the rate of unemployment, I agree to the statement. There is an opportunity cost related with the both which means that if the economy aims to increase the employment opportunities then it would by default deal with the inflation conditions and vice versa. I agreethat though being a trade-off, it's a healthy trade-off for the economy. The reason is quite clear that an economy can't develop with unemployment and it has to make the employment opportunities even if it is at the expense of increasing prices in the economy. Moreover, the increasing prices act as a motivation  for the producers to produce more and sell more which ultimately leads to the increase in GDP of the economy. It is also argued that the inflation upto a certain point is good for the health of an economy because increasing prices simply growing phase for an economy and if the prices are falling then it is said to be bad for an economy as the economy could be going through a slowdown leading to other imbalances in the economy.

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