Question

conomics (Summer 2020) sec. 01 what are the factors that affect Aggregate Demand and Aggregate Supply Curves? Why they are de oping upward sloping and vertical respectively? Answer 2 A- BT /- Next page

Answer 1

Answer- Aggregate demand or domestic final demand is the total demand for final goods and services in an economy at a given time. These are the factors that affect aggregate demand :

1) Net export effect : When domestic prices increase, the demand for imports increases and demand for export decreases.

2) Real balances : When inflation increases, real spending decreases as the value of money decreases. This change in inflation shifts aggregate demand to the left or decrease.

3) Interest rate effect : Real interest rate is the nominal interest rate adjusted to the inflation rate. Lower real interest rate will lower the costs of major products such as cars, large appliances and houses, as a result aggregate demand increase.

4) Inflation expectations : If consumer expect inflation to go up in the future, they will tend to buy now causing aggregate demand to increase or shift to right.

Aggregate supply or domestic final supply is the total supply of goods and services that firms in a national economy plan on selling during a specific time period. These are the factors that affect aggregate supply :

1) Changes in unit labor costs : If labor cost increases, the cost of production increases, this will lead to a decrease in aggregate supply.

2) Change in other production costs : For example rental cost retailers, the price of building materials for the construction industry or the cost of fertilizer used in farming.

3) Commodity prices : Change to raw material costs and other components e.g. the price of oil, natural gas, copper, rubber and other inputs will affect a firm's cost.

4) Exchange rates : Costs might be affected by a change in the exchange rate which cause fluctuations in the price of imported products. A fall in the exchange rate increase the cost of importing raw materials and other components.

5) Government taxation and subsidy : If government increase tax and reduce subsidy, aggregate supply will decrease. If government reduce tax and increase subsidy, aggregate supply will increase.

The upward sloping aggregate supply curve shows the positive relationship between price level and real GDP in the short run. The aggregate supply curve slopes up because when the price level for output increases while the price level of inputs remain fixed, the oppotunity for additional profits encourages more production.

The downward sloping aggregate demand curve shows the relationship between the price level for outputs and the quantity of total spending in the economy.

A vertical demand curve shows that any change in price there are no change in demand. This is perfectly inelastic demand curve.

A vertical supply curve shows that any change in price there are no change in supply. This is perfectly inelastic supply curve.