Individual Assignment Week 5 Exercise AS/AD Keynes Model

Rizqi Ghani Faturrahman

29120382
YP64-B
Business Economics
1. Demonstrate graphically and explain verbally the role the multiplier effect has in the
shape of the aggregate demand curve.
Answer:
The multiplier effect decreases as the aggregate demand curve moves further to the right of the
aggregate supply curve, in general terms. Based on the following graph, we assume that we start
from point A on the AD curve, with P0 as the price level and Y0 as the real production level. The
price has now fallen to P1. When the price level falls, the total quantity required increases from
Y0 to Y1 due to the combination of financial assets, interest rates, and international influences.
This is where the multiplier effect comes in. Increased in expenses related to the movement of Y0
to Y1 that will result in increased income. The increase in revenue will cause another round of
spending increase, which will result in more revenue being generated. The outcome is that the
initial change in cost due to the fall in the price level is multiplied so that based on the graph we
end up with the level of real production Y2 instead of Y1. This means that we are at point C of
AD curve.
2. Using an AS/AD diagram, demonstrate graphically and explain verbally the short run
impact on the price level and real output of an increase in productivity.
Answer:
Based on the graph below, point A on AD and SAS0 represents the initial equilibrium, with price
level P0 and real production level Q”. Increased productivity leads to lower production costs and a
shift in the SAS curve from SAS0 to SAS1. As a result, a new equilibrium is reached at point B,
so at the new equilibrium point. price level is lower (P1< P0) and the quantity of real output is
greater (Y0 > Y1). As worker productivity increases, the aggregate supply curve increases at the
same time. Cost-push inflation means a leftward shift in the aggregate supply curve due to a rise in
the wage level. It means as the aggregate supply curve shifts leftward then the price level rises,
and real GDP falls, and employment also falls into an economy.
3. Demonstrate graphically and explain verbally a recessionary gap. Describe two solutions for
closing the gap.
Answer:

The graph above shows a recession gap of (Y0 - Y1). At point A, the economy is in short-run
equilibrium with the price level P0 and the real output level Y1. A recession gap exists when
equilibrium output is below potential output, as shown in the graph. Graphic A and B below show
two possible solutions to close the recession gap of (Y0 – Y1). Diagram A shows how the gap can
be filled by allowing the economy to repair itself. Diagram B shows how activist government
policies can fill the gap. Here are the graphic of solution A and B:

 Solution A: Allowing the economy to fix the problem on its own entails waiting for an excess
supply of production factors to lead to a reduction in costs and wages. As expenses and wages
decrease, the SAS curve changes from SAS0 to SAS1 and intersects AD at point B.
 Solution B: when the government intervenes and boots spending, AD rises from 0 to 1. As a
result, a new equilibrium is established at point B. At point B, the price level has risen from
P0 to P1, but the real output has risen from Y1 to Y0, closing the recession gap.