Question

Suppose that because of globally adverse meteorological conditions, there are serious concerns of climbing prices in an extensive group of commodities. As a result, people now expect an acute increase in the level of input prices. The figure shows aggregate demand (AD), short‑run aggregate supply (SRAS), and long‑run aggregate supply (LRAS). Move one or more of these curves to describe the short‑run effect this would have in the economy and answer the two questions.

*graph goes here*

In the short run, price level
a. decreases.
b. The change is indeterminate.
c. increases.

2. In the short run, real GDP (or aggregate output)
a. increases.
b. The change is indeterminate.
c. decreases.

Answer 1

From the graph above it can be observed that, in the short run price level increases and real GDP decreases.

Step-by-step explanation:

Input prices are expected to be high and firms' costs are expected to increase. Thus, for any given actual price level, this reduces the quantity of goods and services that firms will supply, which means the short‑run aggregate supply curve shifts to the left (changes in expectations of prices shift the SRAS). This causes the price level to increase and real GDP to decrease.

The increase in expectation of input prices does not change the economy's level of technology or overall productivity. Because of this, an increase in the input price does not change the long‑run aggregate supply. The LRAS curve indicates the amount of goods that the economy could produce if the economy was at full employment.

Likewise, an increase in expectation of input prices does not affect the overall level of demand, so aggregate demand does not shift. Changes in consumption, investment, government spending, and net exports, or C, I, G, and NX, affect AD.

Reading the graph shows that the price level increases and real GDP decreases in the short run. However, this results in higher unemployment, reducing input costs. So in the long run, this causes SRAS to shift back to the right, according to this AD/AS model.