Chapter 16, Problem 12P

To determine

Concept Introduction:

Aggregate Supply Curve (AS): It shows how price and the quantity supplied are related to each other. The curve is positively slopped which means that when prices rise, the quantity supplied also rises. The curve depends on the duration of time.

Short Run Aggregate Supply (SRAS): It is a positively slopped curve in which supply increases when price rises. The reason for upward slopping is that the wages are sticky in the short run due to formal or informal contracts. At higher aggregate prices there is higher profit leading to high level of output.

Long Run Aggregate Supply (LRAS): It is a vertical curve which means it is independent of price. When price increases there is no change in quantity supplied. In the long run nominal wages are not fixed rather it can be negotiated.

Aggregate Demand Curve (AD): It shows how price and the quantity demanded are related to each other. The curve is negatively slopped which means that when prices rise the quantity demanded falls.

Shift in Aggregate Demand Curve: There are several factors on which the shifting of demand curve depends. Some of them are:

• Changes in expectation: when consumers are more confident about future then AD curve shifts in the right direction and vice versa.
• Changes in wealth: when the wealth of an individual increases that means real value of assets increases then the AD curve shifts in right direction and when it decreases then it shifts leftward.
• Size of stock of physical capital: when the size of stock is small then AD curve shifts rightward and vice versa.
• Fiscal policy: It includes government expenditure and taxes. When government expenditure is increased or taxes are decreased then AD curve shifts rightward and vice versa.
• Monetary policy: It includes money supply changes. When money supply increases AD curve shifts rightward and vice versa.