Question

Explain how the following changes in aggregate demand or short-run aggregate supply, other things held unchanged, are likely to affect the level of total output and the price level in the short run.
to. An increase in aggregate demand
b. A decrease in aggregate demand
c. An increase in short-run aggregate supply
d. A reduction in short-run aggregate supply

Answer 1

Suppose that the initial equilibrium level of prices is P, and the output level is Y.

Now, the effect of following changes, keeping other factors constant is as under:

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a) An increase in aggregate demand

Price level will rise, output level will rise

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b) A decrease in aggregate demand

Price level will fall, output level will fall

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c) An increase in short-run aggregate supply

Price level will fall, output level will rise

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d) A reduction in short-run aggregate supply

Price level will rise, output level will fall

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In general, if AD rises, the price level and output level rise. If AD falls, the price level and output level fall.

If AS rises, the price level falls and output level rises. If AS falls, the price level rises and output level falls.

This is due to the basic interaction of demand and supply.