Aggregate Demand Curve and Classical Economy Theory
The aggregate demand curve is a downward-sloping curve and the aggregate supply curve is an upward-sloping curve with price level on the y-axis and aggregate quantity on the x-axis.
1) When the price level changes, there is a movement along the aggregate demand and aggregate supply curves which depends on the direction of change. If the price level increases, there is upward movement along both the curve, and neither curve shifts. There is a decrease in aggregate demand and an increase in aggregate supply.
2) Increase in consumer confidence increases aggregate demand for goods and services in the economy. This causes a rightward shift in the aggregate demand curve and no shift in the aggregate supply curve. Thus, both equilibrium price and quantity increase.
3) Decrease in the supply of resources increases the cost of inputs for the firms for producing goods and services. This causes a decrease in aggregate supply and shifts the aggregate supply curve leftwards while the aggregate demand curve remains the same. This causes an increase in equilibrium price and a decrease in equilibrium quantity.
4) The wage rate decrease will decrease the income of consumers and decrease aggregate demand. On the other hand, this also reduces costs for producers which increases aggregate supply. This causes a decrease in price level while equilibrium quantity may increase, decrease or remain the same depending on the magnitude of the shifts.
The classical theory believes that the long-run aggregate supply curve is inelastic while the Keynesian view does not support this and said that the economy can be below full capacity in the long run.
Keynesians argue for greater emphasis on the role of aggregate demand in causing and overcoming a recession while Classical economists suggest that in the long term, an increase in aggregate demand will just cause inflation and will not increase real GDP.
Keynesians support the idea that there can be a trade-off between unemployment and inflation while the classical view rejects the idea of a trade-off between the two.
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1. Determine whether each of the following would cause a shift in the aggregate demand curve, a shift in the aggregate supply curve, a shift in neither curve nor a shift in both curves. If a shift is caused, indicate which curve shifts, and in which direction it shifts. What happens to aggregate output and the price level in each case?
- The price level changes.
- Consumer confidence increases.
- The supply of resources decreases.
- The wage rate decreases.
There is no minimum word requirement for responses. Please label each section of your response with the appropriate number (1, 2, 3, 4).
2. Compare the classical economic theory that was used prior to the Great Depression to the Keynesian theory used after the Great Depression.
Your response must be at least 200 words in length.
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