Question

Assume the economy is at a full-employment equilibrium. Now, if due to the pandemic, shortages in the supply chain results in higher resource prices, would this, ceteris paribus, be reflected as a change in aggregate demand or a change in aggregate supply? Explain. Be sure to clearly identify a textbook factor of AD or AS that is causing this change. Would this change be an increase or decrease? Explain. Would this change result in the economy moving to a short-run below, or above, full-employment equilibrium? Explain. What do you predict will happen in the short-run to the equilibrium price level, the level of Real GDP and employment in the economy? Explain.

Answer 1

When the economy is at full-equilibrium level, the aggregate demand will be equal to aggregate supply and the equilibrium point in the graph would be where the AD-AS curve intersect with each other.

Assuming everything else remains the same, shortages in supply chain results in higher resource prices, such as raw materials, labor, etc, which in turn will lead to higher cost of production.

The sudden shortage in factors of production or resources would lead to fall in aggregate supply and the equilibrium level will also settle at a higher price level along with a decrease in real GDP as well as employment in the short- run.