The aggregate supply (AS) and aggregate demand (AD) model describe the condition

Question

The aggregate supply (AS) and aggregate demand (AD) model describe the condition of the overall economy; this model is used to predict changes in the price level and output from external shocks to the economy and various government policies.

Please describe what the aggregate supply and aggregate demand curves represent; explain what accounts for their shape (i.e., downward sloping AD and upward sloping AD); and give examples of at least two factors each that might result in a shift in AD and AS.

Explanation / Answer

The aggregate supply curve represents the total amount of goods and services that firms are producing and willing to sell at a given price level in the economy. Its upward slope in the short run is accounted for by the fact that at higher prices, firms seek to increase their output given fixed factor costs Anything that would affect the supply (positively or negatively) of a good would cause the AS curve to shift. The oil embargo in 1973 would be an example of a negative shock, while a positive shock could be a technological innovation that makes production more efficient The aggregate demand curve represents the total amount of final goods and services that will be purchased at all possible price levels at a given time and is the total demand in the economy. It slopes downward (in aggregate) because of wealth, interest rate, and exchange rate effects -since it is composed of consumption, investment and government spending, and exports, these factors. An decrease in net exports due to protective trade policy would shift the aggregate demand curve inward, while an increase in investment spending could shift it outwards.

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