Question

Fill up the blanks by typing in your answer. Do not type in the quotation mark "".

Applying the aggregate demand/aggregate supply model, describe the impact of the following event on GDP and prices in the short run:

Suppose firms become very optimistic about future business conditions and invest heavily in new capital equipment, in teh short run,

_______ (type in "AD" or "AS") will shift to the _______ (type in "right" or "left").

Output will _______(type in "increase" or "decrease") and price will ______ (type in "increase" or "decrease").

Answer 1

1) AD

2) Right

3) increase

4) increase

( This can be explained with the help of the following diagram.Assume that economy was in short run equilibrium before the shift determined by the intersection of aggregate demand curve AD1 and Short run aggregate supply curve SRAS1.initial Equilibrium price is P1 and equilibrium output is Y1. Now, firms invest heavily in investment. There is an increase in investment in the economy. Investment is a component of aggregate demand. Increase in investment leads to a rise in aggregate demand. Aggregate demand curve shifts to right from AD1 to AD2. New equilibrium is determined by the intersection of AD2 and SRAS1. At the new equilibrium, price increases from P1 to P2. Output increases from Y1 to Y1.)