Question

Use Table 13.3 to answer the following questions. $$\begin{array}{c|cc} \hline \begin{array}{c} \text { Price } \\ \text { Level } \end{array} & \begin{array}{c} \text { Aggregate } \\ \text { Supply } \end{array} & \begin{array}{c} \text { Aggregate } \\ \text { Demand } \end{array} \\ \hline 90 & 3,000 & 3,500 \\ \hline 95 & 3,000 & 3,000 \\ \hline 100 & 3,000 & 2,500 \\ \hline 105 & 3,000 & 2,200 \\ \hline 110 & 3,000 & 2,100 \\ \hline \end{array}$$ a. Sketch an aggregate supply and aggregate demand diagram. b. What is the equilibrium output and price level? c. If aggregate demand shifts right, what is equilibrium output? d. If aggregate demand shifts left, what is equilibrium output? e. In this scenario, would you suggest using aggregate demand to alter the level of output or to control any inflationary increases in the price level?

Short answer

The equilibrium output and price level occur where the Aggregate Supply (AS) curve intersects the Aggregate Demand (AD) curve. In this case, the equilibrium output is 3,000, and the equilibrium price level is 95. When AD shifts right, the equilibrium output increases, and when AD shifts left, the equilibrium output decreases. In this scenario, using aggregate demand as a tool to control output may be effective, but it's not ideal for controlling inflationary increases in the price level due to the vertical AS curve implying no change in price level despite shifts in aggregate demand.

Step-by-step solution

1. Sketch Aggregate Supply and Aggregate Demand Diagram

To sketch the Aggregate Supply and Aggregate Demand diagram, we need to plot the given data by setting the price level on the vertical axis and output on the horizontal axis. On the diagram, we will see two curves, one for AS and another for AD.

2. Identify Equilibrium Output and Price Level

Equilibrium Output and Price Level is the point where the Aggregate Supply curve (AS) intersects the Aggregate Demand curve (AD). In other words, it represents the situation when the desired output produced by the producers is equal to the desired output purchased by the consumers.

3. Analyze the Impact of Aggregate Demand Shift to the Right

If Aggregate Demand (AD) shifts to the right, it means that the consumers' desire for goods and services at every price level has increased. As a result, the equilibrium point will change, and we can determine the new equilibrium output and price level.

4. Analyze the Impact of Aggregate Demand Shift to the Left

If Aggregate Demand (AD) shifts to the left, it means that the consumers' desire for goods and services at every price level has decreased. Similar to the previous case, the equilibrium point will change, and we need to determine the new equilibrium output and price level.

5. Evaluate the Use of Aggregate Demand to Control Output and Inflation

Based on the analysis of the impact of shifts in aggregate demand on the economy, we can evaluate whether it would be effective to use aggregate demand as a tool to alter the level of output or control inflationary increases in the price level in this particular scenario.

Key concepts

Equilibrium Output

Equilibrium output is a fundamental concept in economics which happens when aggregate supply (AS) and aggregate demand (AD) meet. In more straightforward words, it’s when what producers want to sell matches up perfectly with what consumers want to buy. This is called the equilibrium point, and here we also find the equilibrium price level.
If you picture a graph, equilibrium output is where the AS and AD curves cross one another. This crossing point ensures no excess supply or demand in the market.

• In a supplied market, having too much of a product that consumers don't want can lead to a decrease in price levels.
• On the flip side, when demand exceeds supply, prices might shoot up.

To balance things in the real world, the economy strives to stay at this equilibrium output level, making sure resources don’t go to waste and consumers remain satisfied.

Price Level

The price level in an economy is a measure that reflects the average of current prices across the entire spectrum of goods and services produced. Picture it like the average price tag you’d find if you checked the cost of every item available in a store!

Understanding price levels is crucial when discussing equilibrium. At the equilibrium price level, the existing resources are used optimally, which means there’s neither a lack nor an abundance of goods and services in the market.

Several factors can influence price levels, such as:

• Changes in the cost of raw materials; if raw materials become more expensive, products do too.
• Wages and labor costs; the higher these are, the pricier the goods become.
• Government policies like taxes or subsidies; higher taxes could increase the overall price level, while subsidies might lower it.

Monitoring and understanding the price level helps economists predict inflation or deflation trends, allowing them to preemptively implement policies to stabilize the economy.

Aggregate Demand Shifts

When we talk about aggregate demand shifts, we're looking at changes in the total demand for goods and services within an economy. Think of it as either more or fewer shopping carts filling up at varying price levels.

If aggregate demand shifts to the right, it indicates an increase in consumers' desire to purchase, potentially driven by factors like increased income or decreased taxes. With this shift:

• The equilibrium output tends to increase.
• The price level might also rise unless new supply meets this additional demand effectively.

On the contrary, when aggregate demand shifts leftward, there’s less consumer interest in buying across all prices. This could be due to higher taxes or reduced consumer confidence. Such a shift usually leads to:

• A decrease in equilibrium output.
• A potential fall in price levels as demand dwindles.

Both shifts, whether to the right or left, come with significant implications for economic policy. Governments often respond by adjusting monetary or fiscal policies to either stimulate or slow down demand, aiding in sustaining economic stability.