INTRODUCTION: The assumptions of an economies Aggregate Demand as the sum of the following components: Consumption (C) +Investment + Government Spending (G) + Net Exports (x-m) is not contested by economists.
This is not the case with Aggregate Supply (AS); there are several controversies among different schools of economists that lead to different thinking about the basic assumptions of the AS curve and therefore they disagree on how to deal with fluctuations in the business cycle such as recessions and overheating during the boom.
- Describe the term aggregate supply.
- Explain, using a diagram, why the short-run aggregate supply curve (SRAS curve) is upward sloping.
- Explain, using a diagram, how the AS curve in the short run (SRAS) can shift due to factors including changes in resource prices, changes in business taxes and subsidies and supply shocks.
- Explain, using a diagram, that the monetarist/new classical model of the longrun aggregate supply curve (LRAS) is vertical at the level of potential output (full employment output) because aggregate supply in the long run is independent of the price level.
- Explain, using a diagram, that the Keynesian model of the aggregate supply curve has three sections because of “wage/price” downward inflexibility and different levels of spare capacity in the economy.
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- Explain, using a diagram, the determination of short-run equilibrium, using the SRAS curve.
- Examine, using diagrams, the impacts of changes in shortrun equilibrium.
- Explain, using a diagram, the determination of long-run equilibrium, indicating that long-run equilibrium occurs at the full employment level of output.
- Explain why, in the monetarist/new classical approach, while there may be short-term fluctuations in output, the economy will always return to the full employment level of output in the long run.
- Examine, using diagrams, the impacts of changes in the long-run equilibrium.
- Explain, using the Keynesian AD/AS diagram, that the economy may be in equilibrium at any level of real output where AD intersects AS.
- Explain, using a diagram, that if the economy is in equilibrium at a level of real output below the full employment level of output, then there is a deflationary (recessionary) gap.
- Discuss why, in contrast to the monetarist/new classical model, the economy can remain stuck in a deflationary (recessionary) gap in the Keynesian model.
- Explain, using a diagram, that if AD increases in the vertical section of the AS curve, then there is an inflationary gap.
- Discuss why, in contrast to the monetarist/new classical model, increases in aggregate demand in the Keynesian AD/AS model need not be inflationary, unless the economy is operating close to, or at, the level of full employment.