Question

What impact would a decrease in the size of the labor force have on GDP and the price level according to the AD/AS model?

Short answer

A decrease in the size of the labor force leads to a leftward shift in the Aggregate Supply (AS) curve in the AD/AS model. This results in a new equilibrium with a lower real GDP and a higher price level. Thus, a smaller labor force negatively impacts the GDP and increases the overall price level in an economy.

Step-by-step solution

Determine the initial equilibrium point

Draw or visualize the initial equilibrium point of the AD/AS model. This point is the intersection between the Aggregate Supply (AS) curve and Aggregate Demand (AD) curve, which shows the level of Real GDP and the price level when the economy is at equilibrium.

Analyze the impact of a decrease in labor force size on Aggregate Supply (AS)

When the size of the labor force decreases, the number of people available to produce goods and services decreases. As a result, the economy's production potential decreases. This causes the AS curve to shift leftwards, which represents a decrease in the overall production at each price level.

Determine the new equilibrium point on the AD/AS model

After the AS curve has shifted to the left, we'll find a new intersection point between AS and AD curves. This new point represents the updated equilibrium with the lower labor force size. In the new equilibrium, both Real GDP and the price level have changed.

Compare the new equilibrium point to the original equilibrium point

The new equilibrium that we find after the AS curve shifted has a lower level of real GDP and a higher price level compared to the original equilibrium point. This illustrates that the decrease in the size of the labor force has led to a decrease in GDP and an increase in the price level.

Conclusion

The decrease in the size of the labor force causes the AS curve to shift leftward. This shift results in a new equilibrium characterized by lower GDP and higher price levels. Therefore, a decrease in the size of the labor force has a negative impact on the GDP and raises the overall price level in an economy according to the AD/AS model.