Question

How is recession illustrated in an AD/AS model?

Short answer

A recession can be illustrated in an AD/AS model by a decrease in aggregate demand, which is represented by a leftward shift of the AD curve (AD'). This results in a new equilibrium, characterized by a decline in both the overall price level and the quantity of goods and services produced (Real GDP). This decline in Real GDP leads to higher unemployment levels and lower incomes, which are typical characteristics of a recession.

Step-by-step solution

Define the Aggregate Demand (AD) and Aggregate Supply (AS) Model

The AD/AS model is an economic tool used to represent the relationship between the total demand for goods and services (aggregate demand) and the total output that firms are willing to produce (aggregate supply) in an economy. Aggregate demand (AD) represents the total amount of goods and services that households, businesses, and the government want to buy at any given price level. Aggregate supply (AS) represents the total amount of goods and services that firms are willing to produce at any given price level.

Plot the AD and AS curves

To illustrate the AD/AS model, you need to draw two curves on a graph. The horizontal axis represents the quantity of goods and services produced (Real GDP), and the vertical axis represents the overall price level. The AD curve is downward sloping, which means that as the price level increases, the quantity of goods and services demanded decreases. The AS curve is upward sloping, which means that as the price level increases, the quantity of goods and services supplied increases.

Identify the initial equilibrium

Locate the point where the AD and AS curves intersect, which represents the initial equilibrium in the economy. At this point, the quantity of goods and services demanded is equal to the quantity of goods and services supplied (Real GDP) and the overall price level is determined.

Illustrate a decrease in aggregate demand

A recession can be represented in the AD/AS model by a decrease in aggregate demand. To show this, draw a new AD curve (AD') to the left of the initial AD curve. This shift represents a decrease in the total amount of goods and services that households, businesses, and the government want to buy at any given price level. This can be caused by a variety of factors, such as a decline in consumer confidence, a decrease in business investment, or a decrease in government spending.

Identify the new equilibrium and describe the results

Locate the point where the new AD curve (AD') intersects the AS curve. This point represents the new equilibrium in the economy during a recession. Comparing the initial equilibrium (before the recession) and the new equilibrium (during the recession), one can observe a decrease in both the overall price level and the quantity of goods and services produced (Real GDP). This decline in Real GDP can lead to higher unemployment levels and lower incomes, which are the characteristics of a recession. To sum up, a recession can be illustrated in the AD/AS model by a decrease in aggregate demand, which results in a decline in both the overall price level and the quantity of goods and services produced (Real GDP). These changes lead to lower incomes and higher unemployment levels, which are the characteristics of a recession.