. Determine whether each of the following situations (a, b and c) would cause a shift of the aggregate demand curve, a shift of the aggregate supply curve (Long run and Short run), neither, or both.
• Which curve shifts, and in which direction? What happens to aggregate output and the price level in each case? Is there an expansionary, contractionary, or no gap between the potential output and the actual output? And, is the unemployment rate lower or higher than the natural rate of unemployment.
a. Consumer confidence declines.
b. The supply of resources increases i.) temporary increase, ii.) permanent increase
c. The wage rate increases
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To determine whether each situation causes a shift in the aggregate demand (AD) curve, aggregate supply (AS) curve in the short run (SR), and aggregate supply curve in the long run (LR), as well as the effects on aggregate output, price level, output gap, and the unemployment rate, we need to consider the impact of the given factors on both demand and supply sides of the economy.
a. Consumer confidence declines:
This situation affects the aggregate demand (AD) curve. When consumer confidence declines, people are less likely to spend, which leads to a decrease in consumption expenditure. As a result, the AD curve shifts to the left. With a leftward shift of the AD curve, both aggregate output and the price level decrease. This implies a contractionary gap between the actual output and the potential output. Additionally, the unemployment rate is likely to be higher than the natural rate of unemployment since decreased aggregate output implies lower demand for labor.
b. The supply of resources increases:
i. Temporary increase:
A temporary increase in the supply of resources affects the aggregate supply (AS) curve in the short run (SR). When the supply of resources increases temporarily, it enables firms to produce more output in the short run. This leads to an increase in aggregate output and a decrease in the price level. The AS curve shifts to the right in the SR. However, in the long run (LR), the AS curve returns to its original position, assuming the increase in resource supply is temporary. The temporary increase in resource supply does not affect the potential output, so there is no output gap. The unemployment rate could be lower if the temporary increase in resource supply creates more employment opportunities.
ii. Permanent increase:
A permanent increase in the supply of resources affects the aggregate supply (AS) curve in the long run (LR). When the supply of resources increases permanently, it enables firms to produce more goods and services in the long run. This leads to an increase in aggregate output and a decrease in the price level. The AS curve shifts to the right in the LR. With an increase in aggregate output, there is no output gap since the actual output matches the potential output. The unemployment rate may decrease if the permanent increase in resource supply creates more employment opportunities.
c. The wage rate increases:
When the wage rate increases, it affects the aggregate supply (AS) curve in both the short run (SR) and the long run (LR). An increase in the wage rate leads to an increase in production costs for firms, resulting in a decrease in aggregate supply. The AS curve shifts to the left in both the SR and LR. With a leftward shift of the AS curve, both aggregate output and the price level decrease. This implies a contractionary gap between the actual output and the potential output. Additionally, the unemployment rate is likely to be higher than the natural rate of unemployment since decreased aggregate output implies lower demand for labor.
In summary:
a. Consumer confidence declines: Shifts the AD curve to the left. Aggregate output and the price level decrease. There is a contractionary gap, and the unemployment rate is higher than the natural rate.
b. The supply of resources increases:
i. Temporary increase: Shifts the AS curve to the right in the SR. Aggregate output increases, and the price level decreases. There is no output gap, and the unemployment rate may decrease.
ii. Permanent increase: Shifts the AS curve to the right in the LR. Aggregate output increases, and the price level decreases. There is no output gap, and the unemployment rate may decrease.
c. The wage rate increases: Shifts the AS curve to the left in both the SR and LR. Aggregate output and the price level decrease. There is a contractionary gap, and the unemployment rate is higher than the natural rate.