Question

mustrate each of the following situations with a graph showing the scgegale supply and aggregate denarnd curves, and explain what happens to the equir librium values of the price level and aggregate out put (a) An increase in G with the money supply beld constast by the Fed. (b) An increase in the price of oil with no change in government spending (e) A decrease in Z with no change in government spending (d) A decrease in the price of oil and an increase in G

Illustrate each of the following sotuations woth a graph showing the aggregate supply and aggregate demand curves, and explain what happens to the equilibrium value pf the price level and aggragate output :

a) an increase in G with the money supply held constant by the Fed

b) an increase in the price of oil with no change in governement spendings

c) a decrease in Z with no change in governement spending

d) an decrease in the price of oil and an increase in G

Answer 1

The Aggregate supply curve depicts the quantity of goods and services an economy can produce with full employment of labor and capital.

The Aggregate demand curve is comprised of the sum of aggregate expenditures:

AD= C+I+G+NX

a) Increase in G with money supply held constant by Fed will lead to the increase in AD and hence will shift the AD to the right.

AD' AS P AD P1 PO YO Y1

The initial equilibrium level was where AS and AD intersect and produce Y0 output at P0 price level. As Government expenditure increase, AD shifts to right to new AD'. The new output level is Y1 and price level is P1.  

b) As the price of oil increase, it becomes more costlier to produce goods thus the supply of goods and services will fall at the given price level. Thus AS curve will shift to the left.

AS' P AD AS P1 PO Y1 YO

The AS curve will shift to AS' leading to the change in the equilibrium Price and output. The new price will be  more than the old price and the new output will decline as increased prices will not be favored.

c) The Z in an economy means the demand for goods. If Z decreases with no change in government spending, it means that the AD will shift to the right due to increased demand.

AD' AS P AD P1 PO YO Y1

Thus, once again, the AD will now shift to AD'. And new equilibrium quantities will be increase price level and increased output level than before.

d) When the price of oil increase; as explained in part b) the AS will shift to the left and now because there is also increase in Government spending, the AD will shift to the right.

AS AS P AD P1 PO Y1 YO

Since both the AS and AD shift the price will be higher in all cases but the output level can vary depending upon by what intensity did the AD curve shifts. Thus output level can be lower than the previous level or can be higher than that depending upon the expenditure by the government.

AD' AS P AD P1 PO YO Y1

AS' P AD AS P1 PO Y1 YO

AD' AS P AD P1 PO YO Y1

AS P AD AS P1 PO Y1 YO