Answer to Question #114395 in Macroeconomics for jasmin

Question

Now assume that there is an increase in government expenditure (G), an
increase in the labour force and a reduction in oil prices. By using the AS-AD graph,
explain the effects of these changes on equilibrium output and equilibrium price level
in the Short-Run. Explain each step in your graph.

Answer 1

 Aggregate demand (AD) refers to total demand of the population in an economy which includes consumption as well as investment demand while aggregate supply refers to sum total of total supply of various factors of production like land and labour productivity, capital investment and entrepreneurial activities.

There is a downward sloping of the aggregate demand curve to the right indicating that as price levels increase or decrease, more or less goods are demanded .While in the aggregate supply curve slopes upwards in the short run.

The curve in aggregate demand slopes downwards to the right showing that at various price levels decreases or increases indicating that more or less goods are needed.

Using the AS-AD curve effects of changes in increase government  expenditure ,increase in     labour force and reduction in oil prices will be affected in the short run.

1)   Increase in government expenditure (G).

 Government expenditure may increase due to the following reasons increase in demand of good education  infrastructure , agriculture. As a result the government may end up borrowing more money from internal and external sources. It may also increase taxes.

Price levels of essentials will go up.

This will result in AS-AD curve shifting to the right. Indicating that the GDP will be greater.

2)   Increase in labour force

This refers to when the majority of the population is employed. Shift in aggregate supply may be caused by improved methods in production processes, innovations, reduced taxes and presense of substitutes and compliments. In the firms there will be greater productivity since the labourers are more leading to more quantity being produced.

3)   Reduction in oil prices.

When oil prices fall they will affect the aggregate demand and supply. Aggregate demand of certain commodities will be affected such as fuels, electricity will go down.

Employment opportunities will also increase since making the curve to shift to the right resulting to a greater growth domestic product (GDP) as illustrated below.

The cost of transport will also decrease , due to these people will save more and invest more.

The AS curve will shift to the right. Production will be encouraged at this level due to low prices.

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