The aggregate demand and aggregate supply (AD‑AS) model shown depicts a hypothetical situation where a recent increase in expected income increases AD. The current AD (post adjustment) is depicted by curve AD1.

Please show what will happen to this economy next (ceteris paribus). Adjust only one of the curves in one direction. The original AD curve cannot be shifted.

The correct answer in this question is to shift the short‑run aggregate supply (SRAS) curve to the left. The new SRAS curve should meet with the AD1 curve and the long‑run aggregate supply (LRAS) curve all at the same point. The SRAS curve should not shift to the left farther than that.

In this example, the increase in expected income increased aggregate demand. The key to this problem is understanding that at the original AD curve, the economy was already at a long‑run, full employment equilibrium. So, this increase in expected income has increased output above the full employment level. After increase in aggregate demand (AD), the AD curve has shifted rightward to AD1, increasing both aggregate output and price level in short run.

This higher output is only temporary. It comes with increased prices, so workers and suppliers adjust their expectations to the higher price level. This decreases short‑run aggregate supply and shifts the SRAS curve to the left. The economy readjusts at the same full employment level of output, but at a much higher level of prices. Higher price level increases the cost of inputs, therefore raising production cost which makes firms reduce production and output. As a result, aggregate supply falls, shifting SRAS curve leftward to SRAS1, intersecting AD1 at the original aggregate output (potential GDP), but at a further higher price level as shown below.

MubeenaD MubeenaD · Answer 2 · 2022-07-26T13:03:34+02:00

The short-run aggregate supply (SRAS) curve should be moved to the left as the answer to this query. The long-run aggregate supply (LRAS) curve and the new SRAS curve should intersect at the same position. Beyond that, the SRAS curve shouldn't go further to the left.

In this instance, the rise in anticipated income raised total demand. The solution to this issue lies in realizing that the economy was already at a long-run, full employment equilibrium at the time of the original AD curve. As a result, output has increased above the threshold of full employment due to this increase in projected income.

After a rise in aggregate demand, the AD curve shifted rightward to AD1, which in the short term increased aggregate output and price level.

What is Aggregate Supply?

The aggregate supply (AS) or domestic final supply in economics refers to the entire amount of products and services that organizations in a national economy hope to sell over a timeframe.

It is the overall value of goods and services that companies in an economy are willing and able to supply for sale at a certain price point.

What is Aggregate Demand?

The overall demand for final goods and services in an economy at a certain period is known as aggregate demand (AD) or domestic final demand (DFD) in the field of macroeconomics.

Effective demand is a common name for it, however other times this term is used to make a distinction.

This is a country's demand for its gross domestic output. It details the volume of goods and services that will be bought at every price point. The aggregate demand is made up of investment, business and government expenditures, consumer spending, and net exports.

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