1. I If the economy is operating on the upward sloping portion of the short-run

Question

1.     I If the economy is operating on the upward sloping portion of the short-run aggregate supply, SAS, curve; show that an increase in aggregate demand, AD, from expansionary fiscal policy will result in an increase in both real income, Y, and the general price level, P.

I If the economy is operating on the upward sloping portion of the short-run aggregate supply, SAS, curve; show that an increase in aggregate demand, AD, from expansionary fiscal policy will result in an increase in both real income, Y, and the general price level, P.

Explanation / Answer

Aggregate supply behaves differently in the short and long run because in the long run, the price level does not affect production, but in the short run it does.

The upward slope of the short run curve is due to the fact that an increase in the overall level of prices increases the quantity of goods and services supplied and conversely a decrease in the price level tends to reduce the quantity of goods and services supplied.

Theories that try to explain the differences between the short run and long runsupply curve all agree that, the quantity of output supplied deviates from its long run, or natural level when the actual price level deviates from the expected price level.

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