Question

Question 1: Draw and carefully describe a graph that utilizes the Aggregate Demand/Aggregate Supply model that would illustrate the current state of the aggregate economy in the United States as of October 2020. The Aggregate Demand/Aggregate Supply Model is first introduced in Chapter 11 (Links to an external site.) of your text and is further explicated in Chapters 12 and 13. Make sure that you explain your graph in your own words.  

You should draw your own AD/AS graph which you can then embed into your post. Your graph needs to be clearly labeled and explained in some detail. Your graph must include an aggregate demand (AD) curve, a short run aggregate supply (SRAS) curve, and a long run aggregate supply curve (LRAS, Potential GDP) curve. You should clearly label both axes of the graph. Identify the current price level using the GDP deflator (Links to an external site.) on the vertical axis and the level of real GDP (Links to an external site.) on the horizontal axis.   You don’t need to plot any other specific data points although you should identify real potential GDP (Links to an external site.) in the third quarter.

Describe the current state of the economy relative to potential GDP. You should use the most recent data from the third quarter of 2020 which will be available on FRED (Links to an external site.) on October 29.

Answer 1

The recent data related to the U.S. economy shows that the economy is in recession because actual GDP in the economy is below the full employment level of GDP in the economy and inflation rate in the economy is also low. In the diagram below, economy is operating at point E1 where AD= SRAS= LRAS. At this level of equilibrium, real GDP in the economy is equal to OY1 and price level is equal to OP1. This leads to fall in the output below the full employment level. The pandemic has led to decline in both aggregate demand and aggregate supply in the economy which has resulted in recessionary gap. This can be depicted as: