Chapter 16, Problem 14P

To determine

Concept Introduction:

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.

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.

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.

Supply Shock: In every economy it is a type of sudden event that leads to change in the supply of output for short period of time. Supply may decrease or increase depending upon the type of shock.

Positive Supply Shock: It is a type of shock in which aggregate supply in an economy expands. It causes price to increase. It is a rare phenomenon.

Negative Supply Shock: It is a type of shock in which aggregate supply in an economy degrades.