This discussion is now closed.

Check out other Related discussions

AS/AD Curve Shift: Short-Run Vs. Long-Run

Hi,

1. Does the shift of either the AS or AD curve always ultimately shift the other curve?

2. Am I missing anything in my answers? Are the answers correct?

Examples:

Q: Use the AS/AD model to explain links between productivity, AD, and prices. Supplement answer w/ graph.

A: Increased productivity shifts the AS curve out to the right, thereby increasing both Y (Income/output) and Price.

What happens next? Is there a shift of the AD curve in the long run?

Q: The ongoing recession in Asia has lowered Asian demand for U.S. goods and services. Using the AS/AD model, what is predicted Short-run effects of this change on aggregate prices and aggregate income/ What is the process by which the economy adjusts to this new equilibrium? Explain your answers clearly and carefully. Use a graph to illustrate your answer.

A:

1. The recession causes a left shift of the AD curve. However, assuming that prices remain sticky, there is only a decrease in Y, or output/income.
AD down --> Demand for exports down --> Exports down --> Net exports down --> Y down
2. Y down --> Output produced down --> D inputs down --> P outputs down --> P level down
3. P level down --> interest rates down --> Investment/AE up --> Y up
P level down --> P exports down --> EX up --> NS up --> Y up
4. Y growth = economic growth --> right shift AS curve

LR result? Y same as before, P level down from initial

Reply 1

john !!

14

For the first question I don't know why AD would change.

Will people's demand for goods and services change if productivity increases? I don't see any reason why.

Reply 2

Ellie4

2

MusicLover7

1. The recession causes a left shift of the AD curve. However, assuming that prices remain sticky, there is only a decrease in Y, or output/income.
AD down --> Demand for exports down --> Exports down --> Net exports down --> Y down
2. Y down --> Output produced down --> D inputs down --> P outputs down --> P level down
3. P level down --> interest rates down --> Investment/AE up --> Y up
P level down --> P exports down --> EX up --> NS up --> Y up
4. Y growth = economic growth --> right shift AS curve

LR result? Y same as before, P level down from initial

Is it just me, or does this not follow? :confused:

Reply 3

Juneau

2

Strumpet

Is it just me, or does this not follow? :confused:

I dont think that is right either- a drop in interest rates would lead to a fail in hot money moving into the economy and therefore a decrease in investment...or thats how i would read the situation anyway :rolleyes:

Reply 4

Ellie4

2

Juneau

I dont think that is right either- a drop in interest rates would lead to a fail in hot money moving into the economy and therefore a decrease in investment...or thats how i would read the situation anyway :rolleyes:

Exactly what I though. It'd discourage investment!

Reply 5

Steerz

2

I always thought that a decrease in interest rates would make loans etc cheaper. Consumers would also be likely to spend more money too, thus making investment increase.

I'm confused! :confused:

Reply 6

Jessie

9

A fall in interest rates should increase investment because the opportunity cost of taking out a loan is reduced. There is a negative relationship between the interest rate and investment, you can find it in most basic degree textbooks as the IS curve. Also, hot money does not equal FDI. Hot money is mostly people moving their savings and bonds around the world to benefit from the best interest rate. A relatively lower interest rate in the country should increase Foreign Direct Investment because the foreign company would be paying less interest

Reply 7

john williams

15

Strumpet

Is it just me, or does this not follow? :confused:

Nope its just you! When i read this thread last week i was also confused but didnt bother replying, however a fall in interest rates would increase investments (as Jessie said)...do foreign savings count as investments..

Reply 8

Finn

foreign direct investment definitely counts towards aggregate demand so this could be an evaluation point, but most definitely a fall in base rates will improve the incentive for businesses and consumers alike to invest. with respect to the idea of hot money flows you must conclude that the main importance is relative interest rates.

your first question which links productivity with aggregate demand is odd.

yes it will push out the aggregate supply curve which effectively represents the ppf of a country. as far as ad goes (c+i+g+x-m), i can only think that indirectly increased productivity makes a country more competitive abroad and could induce rises in exports pushing out AD. Funnily enough although there is no injection immediately into aggregate demand, increased productivity will lead to accelerated effects of confidence, growth and further investment.

your second question: "The ongoing recession in Asia has lowered Asian demand for U.S. goods and services. Using the AS/AD model, what is predicted Short-run effects of this change on aggregate prices and aggregate income/ What is the process by which the economy adjusts to this new equilibrium? Explain your answers clearly and carefully. Use a graph to illustrate your answer."

I think theyre asking about the US economy...because they effectively tell you that demand for us good and services has fallen.

Reply 9

Sleep

1. Does the shift of either the AS or AD curve always ultimately shift the other curve?

Possibly. Need to think both ways. If AS shifts to the right, prices drop and the economy is capable of producing more goods. Because of this capability, it can be argued that governments will intervene to achieve what is percieved as the best output level (Balancing inflation and economic growth) and will help to shift AD to the right as well. If consumers are reactive, increased AS implies more factor incomes. This implies more consumer expenditure and more investment to take advantage of this investment implying an increase in AD due to increase in AD.

Vice versa, if firms are reactive, then one might assume that an increase in aggregate demand leads to an increase in aggregate supply to take account of the increasing prices relative to other countries. This, as well as the increase in AD itself, implies increased investment, which implies capital goods, which implies a AS shifting to the right.

Q: Use the AS/AD model to explain links between productivity, AD, and prices. Supplement answer w/ graph.

A: Increased productivity shifts the AS curve out to the right, thereby increasing both Y (Income/output) and Price.

No price doesnt, it drops. Productivity therefore drops prices.
AD shifting increases price. But the increase in price depends on the position of long-run aggregate supply. Whether Keynsian/monetarist/alternative analyses of long-run AS varies. Certainly for mine, OCR, it is. Basically, in a Keynesian model, AS is horizontal, vertical or in between depending on the state of the economy. Increase in AS implies the position where it goes vertical shifts outwards, so AD results in more economic growth and inflation than it would before (really need a diagram for that one).

What happens next? Is there a shift of the AD curve in the long run?
No, unless increased investment allows for AS to shift outwards leading to higher wages leading to higher consumer expenditure.

Q: The ongoing recession in Asia has lowered Asian demand for U.S. goods and services. Using the AS/AD model, what is predicted Short-run effects of this change on aggregate prices and aggregate income/ What is the process by which the economy adjusts to this new equilibrium? Explain your answers clearly and carefully. Use a graph to illustrate your answer.

Your reasoning is not clear to me.
However, ill sum it: lower AD. In short-run, lower prices, lower level of output, aggregatve income goes down.
Economy adjusts through government intervention (interest rates, supply side policies, whatever) but what this question is getting at I think is that due to the lower AD firms may choose to invest elsewhere where they can most profitably gain.

A lot of this international analysis is really to do with seeing the world as a market with various barriers to entry in which firms compete to achieve normal profit on an international scale.

Reply 10

Tidasquall

john williams

Nope its just you! When i read this thread last week i was also confused but didnt bother replying, however a fall in interest rates would increase investments (as Jessie said)...do foreign savings count as investments..

That it is true, I just want to clarify - when economists speak about investment they aren't talking about savings in a bank, they are talking about the amount of money firms spend towards buying capital goods, if interest rates decrease, the cost of borrowing money from loans decreases, therefore firms will increase investment as they can buy more capital goods for the same money.

AS/AD Curve Shift: Short-Run Vs. Long-Run

Related discussions

Latest

Trending

Trending

Articles for you