Question

Between 1990 and \(2009,\) the U.S. price level rose by about 64 percent while real output increased by about 62 percent. Use the aggregate demand-aggregate supply model to illustrate these outcomes graphically. LO38.2

Short answer

Both the aggregate demand and aggregate supply curves likely shifted rightward, explaining the increases in both price level and real output in the U.S. from 1990 to 2009.

Step-by-step solution

Understanding the Increase in Price Level

The problem states that the U.S. price level increased by 64% from 1990 to 2009. In the context of the aggregate demand-aggregate supply (AD-AS) model, an increase in the price level can be represented graphically as a shift in the aggregate demand curve (AD) or the aggregate supply curve (AS). This indicates inflation, where the overall level of prices for goods and services rises.

Understanding the Increase in Real Output

During the same period, real output increased by 62%. In the AD-AS model, real output is depicted on the horizontal axis. An increase in real output means that the economy is producing more, which could result from a rightward shift of the aggregate supply (AS) curve, the aggregate demand (AD) curve, or both.

Graphical Representation of Shifts

In the AD-AS model, the aggregate demand curve might shift to the right due to increased spending by consumers, businesses, or the government. Simultaneously, the aggregate supply curve could also shift to the right due to technological advancements, an increase in resources, or other factors that increase production capabilities.

Interpreting the Results

The rightward shift in both AD and AS can result in higher levels of output with an increase in the price level. However, since both price levels and output have increased significantly, it is likely that both curves shifted, with AD possibly increasing due to factors like increased consumer spending, and AS increasing due to technological and productivity improvements.

Key concepts

Price Level

The price level refers to the average of current prices across the entire spectrum of goods and services produced in the economy. It gives a snapshot of the economy's current pricing stance. When the price level rises, it typically indicates inflation, meaning the value of money falls as each unit can purchase fewer goods and services.

In the Aggregate Demand-Aggregate Supply (AD-AS) model, the price level is depicted on the vertical axis. Changes in the price level are shown by movements along the demand and supply curves. An increase in the price level, such as the 64% increase from 1990 to 2009, suggests that inflationary forces were at play.

• This could be due to increased demand for goods and services.
• Or adjustments in aggregate supply due to factors like supply chain constraints.

Understanding how these adjustments occur in the AD-AS model helps illustrate economic realities comprehensively.

Real Output

Real output, also known as real GDP, is the total value of all goods and services produced, adjusted for price changes or inflation. It reflects the actual productivity of an economy. In the AD-AS model, real output is shown on the horizontal axis. An increase in real output indicates that the economy is producing more, signifying economic growth.

During the 1990-2009 period, U.S. real output rose by 62%. Such growth can be visualized in the AD-AS model through shifts in the supply and demand curves.

• A rightward shift in the aggregate supply (AS) curve indicates increased production potential.
• A rightward shift in the aggregate demand (AD) curve shows enhanced demand for goods and services.

These shifts highlight the dynamic nature of the economy as it responds to changing conditions and new opportunities.

Inflation

Inflation is the rate at which the general level of prices for goods and services rises, eroding purchasing power. In the AD-AS model, inflation is represented by an upward shift in the price level over time. During the 1990 to 2009 period, a 64% increase in price levels showed significant inflation.

This inflation could result from various factors influencing both sides of the economy.

• Increased consumer and business demand can push prices up, shifting the AD curve to the right.
• Cost-push factors, such as higher production costs, can shift the AS curve to the left, also raising prices.

By analyzing these trends, policymakers can better understand the underlying causes of inflation and devise strategies to manage it effectively.

Economic Growth

Economic growth refers to an increase in the production of economic goods and services, compared from one period to another. It is traditionally measured as a percentage increase in real GDP per annum. In the AD-AS model, economic growth is depicted as a rightward shift in the aggregate supply curve and/or aggregate demand curve.

The 62% rise in real output from 1990 to 2009 signals robust growth in the U.S. economy. This could be due to:

• Technological advancements, leading to higher productivity.
• More efficient use of resources.
• Increases in labor force or investments in capital.

Such growth is essential for improving living standards and can positively impact employment and national income patterns.