Question

Evaluate the effects of aggregate demand and supply shocks on equilibrium real GDP in the short run

Short answer

When there is an aggregate supply shock, the price level and real GDP move in opposite ways. The price level lowers as supply rises, whereas output rises. When supply is reduced, prices rise and output decreases.

Step-by-step solution

Evaluate the effects of aggregate demand 

The quantity demanded at each price is measured by the demand curve. Consumer spending, corporate spending, government spending, and exports minus imports are the five components of aggregate demand. The formula for aggregate demand is$\mathrm{AD}=\mathrm{C}+\mathrm{I}+\mathrm{G}+(\mathrm{X}-\mathrm{M}).$

Supply shocks on equilibrium real GDP 

In the near run, if aggregate demand rises to ${\mathrm{AD}}_2$, both real GDP and the price level rise. In the short run, both real GDP and the price level decline if aggregate demand falls to ${\mathrm{AD}}_3$.