Question

Q.1.1 Explain, using the AD-AS model, the effect of an increase in investment in the macroeconomy on the equilibrium price level and the equilibrium level of output.

Answer 1

Due to an increase in investment the aggregate demand in the economy increases. As a result, the aggregate demand curve shifts to the right. Due to this, the equilibrium price and equilibrium level of output both rise.

According to the above figure, the x-axis measures the real GDP, and the y-axis measures the price level. Initially, the equilibrium occurs at E where the AD and AS intersect each other. Due to an increase in investment the AD curve shifts to the right and equilibrium price rises from P to P1. The equilibrium quantity also rises from Y to Y1.