Activity 4(f)

Activity 4f Factors affecting AD and AS

1. If interest rates fall, then those with variable rate mortgages experience an increase in their discretionary income. Some of this extra income may be spent in the economy (on consumption goods for example). The AD curve therefore shifts to the right and the level of production increases to meet the demand (assuming the economy is not operating at its productive capacity). With more production, the derived demand for labour increases and this could result in a lowering of the unemployment rate. The impact on prices will depend on which model is chosen (prices increase if the new classical representation of AS is used).

2.If China’s rate of growth increases, they may need more of Australia’s minerals to facilitate that growth. This also lead to the AD curve shifting right so GDP increases, employment increases and price levels will increase (if the economy experiences shortages in some areas).

3. A severe drought will reduce the capacity of Australia’s agricultural sector to produce goods which ultimately means that the capacity of the economy to supply goods and services is diminished. This will shift the AS curve to the left and result in lower levels of economic growth (real GDP) and an increase in prices/inflation over time as shortages develop and producers bid up prices.

5.  A tax cut will increase the disposable income of workers. They may choose to spend a portion of this extra income (equal to their MPC). This will shift the AD curve to the right and lead to a higher equilibrium level of real GDP and help to create employment opportunities. If the economy is operating near full capacity this will create shortages in markets and the general level of prices will rise (operating near the vertical section of the Keynesian AS curve).

6. This represents an increase in G, which is a component of AD. It will also have a positive long-term effect on AS because the infrastructure is likely to expand the nation’s productive capacity and help reduce costs of production for private firms. Both the AD and AS curves shift right in the long run, resulting in a higher levels of real GDP, employment whilst maintaining relatively stable prices.

7.  A depreciation of the AUD will also have AD and AS effects but in reality the effect on AD tends to be greater. The depreciation reduces the price of Australian exports, when expressed in foreign currency. The demand for X therefore increases. At the same time imports become more expensive for Australians, so rather than buying imports they turn to Australian made goods and services instead. The cost of production for firms who use imported components may rise and this could cause the level of AS to fall. If the AD curve shifts right and the AS curve shifts left, the effect on GDP and employment will probably be positive (because the demand side effect is greater) but the general level of prices would be expected to rise.

8. Artificial intelligence will help to reduce production costs and result in a rightward shift of the AS curve. This may place downward pressure on prices and may promote an increase in real GDP. The impact on employment is less clear cut because the introduction of artificial intelligence will cause increases in structural unemployment.