Question

During spring 2016 the Midwestern United States, which has a large agricultural base, experiences above average rainfall. Using the AD/AS diagram, what is the effect on output, the price level, and employment?

Short answer

In summary, the above-average rainfall in the Midwestern United States during spring 2016 negatively impacted the agricultural sector, causing a decrease in production. This led to a leftward shift in the Aggregate Supply curve which resulted in a decrease in Real GDP (output), an increase in the overall price level, and a decrease in employment within the agricultural sector and potentially related industries.

Step-by-step solution

Identify the effect of above-average rainfall on agriculture

Above-average rainfall will likely have a negative impact on agriculture. Too much rain can cause flooding, leading to destruction of crops. This will result in a decrease in agricultural production.

Determine the effect of decreased agricultural production on Aggregate Supply (AS)

A decrease in agricultural production will lead to a decrease in the overall supply of goods and services in the economy. As a result, the Aggregate Supply curve will shift to the left.

Analyze the effect of the shift in the AS curve on output, price level, and employment

When the AS curve shifts to the left, we will see the following effects on output, price level, and employment: 1. Output: The equilibrium level of Real GDP (the output produced by the economy) decreases due to the decrease in agricultural production. 2. Price level: Since there is less supply of goods and services, the overall price level in the economy will increase according to the law of supply and demand. 3. Employment: As the production decreases, fewer workers are needed. This will lead to a decrease in employment in the agricultural sector and potentially in related industries as well.

Summarize the effects of above-average rainfall on output, price level, and employment using the AD/AS diagram

To summarize, above-average rainfall in the Midwestern United States leads to a decrease in agricultural production. As a result, the AS curve shifts to the left. This causes the equilibrium level of Real GDP to decrease, the overall price level to increase, and employment to decrease in the agricultural sector.

Key concepts

AD/AS Model

The Aggregate Demand and Aggregate Supply (AD/AS) Model is a fundamental tool in economics that helps us understand the dynamics of an economy. It illustrates how different factors can affect a country’s total output, inflation, and employment levels. This model uses two main curves: Aggregate Demand (AD) and Aggregate Supply (AS).

• Aggregate Demand (AD) represents the total demand for goods and services within an economy at a given overall price level and in a given period.
• Aggregate Supply (AS) illustrates the total output of goods and services firms are willing to sell at a given price level.

These two curves intersect at a point known as the equilibrium. Changes in economic conditions can shift these curves, impacting the overall economy. For instance, in the scenario of above-average rainfall, excessive moisture negatively impacts agricultural supply, causing the AS curve to shift left, reflecting that supply has decreased while demand remains unchanged. This shift affects the levels of Real GDP, the price level, and employment.

Real GDP

Real Gross Domestic Product (Real GDP) is a key economic indicator that measures the value of all final goods and services produced within a country during a specific period, adjusted for inflation. It provides a more accurate representation of an economy’s size and how it shifts over time than nominal GDP, which doesn't account for changes in price level.

When the Aggregate Supply curve shifts left due to decreased agricultural production, Real GDP decreases. This reflects a reduction in the economy's output and indicates that fewer goods and services are available. A fall in Real GDP can be a sign of economic contraction, affecting business revenues and employment rates, leading to broader economic concerns.

Price Level

The price level in an economy represents the average of current prices across a set of goods and services. It is an important concept because it affects the purchasing power of money and can influence economic behavior.

• A shift to the left in the AS curve, as seen with reduced agricultural supply, typically causes the price level to rise. This is driven by a shortage of available goods and services, which increases competition among buyers, driving prices up.
• Increased prices can lead to inflationary pressures, reducing the real value of money and potentially impacting consumer purchasing power.

Policy-makers closely monitor such changes to implement measures that maintain economic stability and manage inflation.

Employment

Employment levels are an essential indicator of an economy’s health, directly affected by changes in output and price levels. In the AD/AS Model, shifts in Aggregate Supply or Demand can significantly impact employment rates.

• As the AS curve shifts left due to reduced agricultural production, the demand for workers in agriculture and related industries tends to fall. This can result in layoffs or reduced hiring, increasing unemployment.
• Additionally, as the price level rises, costs for businesses may increase, potentially leading to broader impacts on employment beyond just the agricultural sector.

Understanding these dynamics allows economists and policymakers to devise strategies to mitigate such impacts, aiming to stabilize the employment rate and support affected workers during economic downturns.