Question

Use AD-AS analysis to show how each of the events below will affect the equilibrium price level and real output in an economy in the short run when the aggregate supply curve is upward-sloping. Your answer must include a graph and explanation in words.Government spending increases.
New technology increases the productivity of workers.

Answer 1

Higher government spending will increase aggregate demand, shifting AD curve rightward and increasing both price level and real GDP. At the same time, higher productivity will increase aggregate supply, shifting SRAS curve rightward, decreasing price level and increasing real GDP.

In following graph, initial equilibrium is at point A where AD0 (aggregate demand) and SRAS0 (short-run aggregate supply) curves intersect, with initial equilibrium price level P0 and real GDP Y0. Higher government spending shifts AD0 rightward to AD1 and higher productivity shifts SRAS0 rightward to SRAS1, intersecting AD1 at point B with higher real GDP Y0 and new price level P1. New price level will be higher, lower or the same on basis of whether rightward shift in AD curve is higher than, lower than or equal to the rightward shift in SRAS curve. In this case both curves shift by same magnitude, so P1 = P0.