Based on the AS-AD framework,

Based on the AS-AD framework, explain and demonstrate the effectof the following situations on the equilibrium income and pricelevels

i)   An increase in the cost of imported goods thatare used as inputs for domestically produced products.


Pressures for inflation to rise or fall are shown in the AD/ASframework when the movement from one equilibrium to another causesthe price level to rise or to fall.

Redistribution effect: if the import duty causes an increase inthe price of domestically produced goods, it amounts toredistribution of income between the consumers and producers infavour of the producers. … This higher spending within thecountry may cause an expansion of domestic income andemployment.

First, exports boost economic output, as measured by grossdomestic product. 3 They create jobs and increase wages. Third,countries with high import levels must increase their foreigncurrency reserves. That’s how they pay for the imports 5 That canaffect the domestic currency value, inflation, and interestrates.

Growth and recession in the AD/AS model

We can examine both long-term and short-term changes in grossdomestic product, or GDP, using the AD/AS model. In an AD/ASdiagram, long-run economic growth due to productivity increasesover time is represented by a gradual rightward shift of aggregatesupply. The vertical line representing potential GDP—thefull-employment level of gross domestic product—gradually shifts tothe right over time as well. You can see this effect in AD/ASdiagram A below, which shows a pattern of economic growth overthree years.

However, the factors that determine the speed of this long-termeconomic growth rate—like investment in physical and human capital,technology, and whether an economy can take advantage of catch-upgrowth—do not appear directly in an AD/AS diagram.

In the short run, GDP, falls and rises in every economy becausethe economy dips into recession or expands out of recession. Whenan AD/AS diagram shows an equilibrium level of real GDPsubstantially below potential GDP—as is shown within the diagrambelow at equilibrium point \text{E0}E0start text, E, 0, end text—itindicates a recession. On the opposite hand, in years of resurgenteconomic process the equilibrium will typically be on the brink ofpotential GDP—as it’s at equilibrium point \text{E1}E1start text,E, 1, end text.

Unemployment within the AD/AS diagramWe can examine two differing types of unemployment using an AD/ASdiagram—cyclical unemployment and therefore the natural rate ofunemployment. Cyclical unemployment bounces up and down consistentwith the short-run movements of GDP. The long-term, baseline levelof unemployment that happens year in and year out, however, isnamed the natural rate of unemployment.The natural rate of unemployment is decided by how well thestructures of market and government institutions within the economycause an identical of workers and employers within the market .Potential GDP can imply different unemployment rates in severaleconomies, counting on the natural rate of unemployment for thateconomy.In an AD/AS diagram, cyclical unemployment is shown by how closethe economy is to the potential or full-employment level of GDP.Take another check out the AD/AS diagram above. Relatively lowcyclical unemployment for an economy occurs when the extent ofoutput is on the brink of potential GDP, as at the equilibriumpoint \text{E1}E1start text, E, 1, end text. On the opposite hand,high cyclical unemployment arises when the output is substantiallyto the left of potential GDP on the AD/AS diagram, as at theequilibrium point \text{E0}E0start text, E, 0, end text.The factors that determine the natural rate of unemployment aren’tshown separately within the AD/AS model, although they’reimplicitly a part of what determines potential GDP, orfull-employment GDP, during a given economy.Inflationary pressures within the AD/AS diagramInflation fluctuates within the short run, and better inflationrates typically occur either during or simply after economic booms.for instance , the most important spurts of inflation within the USeconomy during the 20th century followed the wartime booms of war Iand war II. On the opposite hand, rates of inflation generallydecline during recessions.The AD/AS framework implies two ways in which inflationarypressures may arise. One possible trigger is that if aggregatedemand continues to shift to the proper when the economy is alreadyat or near potential GDP and financial condition , thus pushing themacroeconomic equilibrium into the steep portion of the mixturesupply curve. Let’s check out diagram A, on the left below. duringthis diagram, you will see a shift of aggregate demand to theproper . The new equilibrium \text{E1}E1start text, E, 1, end textis at a better price index than the first equilibrium\text{E0}E0start text, E, 0, end text. during this situation, themixture demand within the economy has soared so high that firmswithin the economy aren’t capable of manufacturing additional goodsbecause labor and physical capital are fully employed, thenadditional increases in aggregate demand can only end in anincrease within the price index .

The two graphs show how a shift in aggregate demand or supplycan cause inflationary pressure. The graph on the left shows twoaggregate demand curves to represent a shift to the proper . Thegraph on the proper shows two aggregate supply curves to representa shift to the left.Another source of inflationary pressures may be a rise in inputprices that affects many or most firms across the economy—perhaps acrucial input to production like oil or labor. this example cancause the mixture supply curve to shift back to the left. Indiagram B above, the shift of the SRAS curve to the left alsoincreases the worth level from \text{P0}P0start text, P, 0, endtext at the first equilibrium \text{E0}E0start text, E, 0, end textto a better price index of \text{P1}P1start text, P, 1, end text atthe new equilibrium \text{E1}E1start text, E, 1, end text. Ineffect, the increase in input prices ends up—after the ultimateoutput is produced and sold—being passed along within the sort of abetter price index for outputs.An AD/AS diagram shows only a one-time shift within the price index.The aggregate demand/aggregate supply, or AD/AS, model is one amongthe elemental tools in economics because it provides an overallframework for bringing economic factors together in onediagram.We can examine long-run economic process using the AD/AS model, butthe factors that determine the speed of this long-term economicprocess rate don’t appear directly within the AD/AS diagram.Cyclical unemployment is comparatively large within the AD/ASframework when the equilibrium is substantially below potential GDPand comparatively small when the equilibrium is near potentialGDP.The natural rate of unemployment—as determined by the marketinstitutions of the economy—is built into potential GDP, butdoesn’t otherwise appear in an AD/AS diagram.

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