Consider a typical short-run AS/AD model which consists of AD and SRAS curves. I
ID: 1195351 • Letter: C
Question
Consider a typical short-run AS/AD model which consists of AD and SRAS curves. In each of the following cases, in the short run, determine whether the events cause a shift of a curve or a movement along a curve. Determine which curve is involved and the direction of the change. (You don’t need to draw a graph in this problem. Explain in words.)
(1) An increase in the quantity of money by the Federal Reserve increases the quantity of money that people wish to lend, lowering interest rates.
(2) Greater union activity leads to higher nominal wages.
(3) A fall in the aggregate price level increases the purchasing power of households’ and firms’ money holdings. As a result, they borrow less and lend more.
Explanation / Answer
1. This will shift the AD curve to the right. As the Fed increases the money supply and the interest rates are lowered, now people would be more willing to invest and consumer. Increasing the aggregate demand.
2. This will shift the AS curve to the left. By negotiating higher wages, the production cost of the producers would shoot up, forcing firms to produce less and save some on profits.
3. Movement along the curve.
Due to price level fall and purchasing power rise, the households and firms borrow less and lend more, the consequence is fall in interest rates, this further agrravates investment and consumption to increase. This fall in price level leading to fall in interest rates results in movement along the curve.