Answer to Question #94446 in Macroeconomics for Nomthandazo

Question

the AD-AS model, a simultaneous decrease in output and price level in the economy is an outcome of ….
(1) a supply shock
(2) an increase in the cost of production
(3) contractionary demand management policies
(4) a reduction in wage rates bargained by labour unions

Answer 1

 (3) Contractionary demand management policies

AD-AS model is a way of illustrating determination of national income and price level changes. It has the aggregate demand curve, short-run aggregate supply curve, and long-run aggregate supply curve. When the government introduces contractionary demand management policies, the aggregate demand curve (AD) shifts to the left. Such policies include when there is an increase in taxes, which will lead to decrease in income of households leading to less spending, and thus the AD curve shifts to the left. With the this policy, the short-run aggregate supply curve states how demand curve shift affect the real output and price level in the short run, all other things being constant. Thus, a contraction demand management policies will cause a shift in the AD to the left, leading to a decrease in both price level and output with all other things being constant.