Question

Suppose that the aggregate demand and aggregate supply schedules for a hypothetical economy are as shown in the following table.

Amount of Real GDP Demanded, Billions	Price Level (Price Index)	Amount of Real GDP Supplied, Billions
\(100	300	450
200	250	400
300	200	300
400	150	200
500	100	100

a. Use the data above to graph the aggregate demand and aggregate supply curves. What are the equilibrium price level and the equilibrium level of real output in this hypothetical economy? Is the equilibrium real output also necessarily the full-employment real output?

b. If the price level in this economy is 150, will quantity demanded equal, exceed, or fall short of the quantity supplied? By what amount? If the price level is 250, will the quantity demanded equal, exceed, or fall short of the quantity supplied? By what amount?

c. Suppose that buyers desire to purchase \)200 billion of extra real output at each price level. Sketch in the new aggregate demand curve as AD₁. What are the new equilibrium price level and level of real output?

Short answer

a. The AD-AS model is shown below.

The equilibrium output is $300 billion, and the equilibrium price is $200.

The equilibrium output is not necessarily the full-employment output.

b. At the 150 price level, the aggregate quantity demanded exceeds the supply by $200 billion. At the 250 price level, the aggregate quantity demanded falls short of the supply by $200 billion.

c. The new aggregate demand curve AD₁ is shown in the diagram given below.

The new equilibrium output is $400 billion, and the equilibrium price is 250.

Step-by-step solution

AD-AS graph and equilibrium output and price

The aggregate demand is a negatively sloped curve because of wealth, interest, and exchange rate. In contrast, the aggregate supply curve is positively sloped.

The AD curve in the above graph is a negatively sloped straight line as the real output increases constantly by $100 billion for each decline of 50 in the price level.

The AS curve is not a straight line, although it is positively sloped because the rate of increase in the real output for a corresponding increase of 50 in the price level is not constant, as shown in the graph.

The real output, at which the aggregate output demanded equals the supply, is the equilibrium level of output, and the corresponding price is the equilibrium price.Since the AD and AS curves intersect at $300 billion of real GDP where the price level is 200, the equilibrium output is $200 billion, and the equilibrium price is 200.

The equilibrium output is not necessarily the full-employment output. The difference between the two outputs causes a GDP gap which may lead to inflation or recession.

Difference between AD and AS at 150 and 250 price levels

If the price level is 150, the quantity supplied is $200 billion, and the quantity demanded is $400 billion. Thus, the quantity demanded exceeds the supply by $200 billion.

When the price level is 250, the quantity supplied is $200 billion, and the quantity demanded is $200 billion. Hence, the quantity demanded falls short of the supply by $200 billion.

Shift in the aggregate demand curve

The buyers’ desire to purchase $200 billion more of real output at each price level increases the aggregate demand by $200 billion, as shown in the table given below.

Amount of Real GDP Demanded, Billions	Price Level (Price Index)	Amount of Real GDP Supplied, Billions
$300 (= 100 + 200)	300	450
400 (= 200 + 200)	250	400
500 (= 300 + 200)	200	300
600 (= 400 + 200)	150	200
700 (= 500 + 200)	100	100

The aggregate demand curve (AD1) has shifted toward the right by $200 billion of the real GDP. Since the aggregate demand curve (AD1) intersects the supply curve at $400 billion of real GDP, $400 billion is the equilibrium output, and the equilibrium price is 250.