Suppose the economy is producing below the natural rate of output and the government is suffering from large budget deficits. To deal with the deficit problem, suppose the government takes a policy action to reduce the size of the deficits. This policy action will cause ________ in the unemployment rate in the short run and ________ in the aggregate price level in the short run, everything else held constant.

Aggregate demand and aggregate supply are macroeconomic concepts that describe the relationship between the total demand and supply of goods and services in an economy. The aggregate demand-aggregate supply (AD-AS) model shows how these two concepts interact and how they change during an economic boom or recession. The model is represented graphically, with price level on the Y-axis and real GDP on the X-axis.  Aggregate demand: The total amount of spending people are willing to make on domestic goods and services at a given price level. This includes consumer spending, business spending,... Show more

Aggregate demand and aggregate supply are macroeconomic concepts that describe the relationship between the total demand and supply of goods and services in an economy. The aggregate demand-aggregate supply (AD-AS) model shows how these two concepts interact and how they change during an economic boom or recession. The model is represented graphically, with price level on the Y-axis and real GDP on the X-axis. 

Aggregate demand: The total amount of spending people are willing to make on domestic goods and services at a given price level. This includes consumer spending, business spending, government spending, and exports minus imports. The formula for aggregate demand is AD = C + I + G + [X - M]. 
Aggregate supply: The total amount of goods and services that firms in an economy plan to sell during a specific time period, at given price levels. This includes factor prices, technology, labor and capital productivity, government rules, subsidies, and taxes, and the availability of factors of production. 
The supply curve shows the relationship between the price level of goods supplied to the economy and the quantity of the goods supplied. In the short run, the supply curve is fairly elastic, but in the long run, it is fairly inelastic (steep). The supply curve slopes upward, indicating that as the price per unit goes up, a firm will supply more. Eventually, the supply curve becomes vertical, indicating that at a certain price point a firm cannot produce anymore. 
Macroeconomic equilibrium is a state where aggregate supply equals aggregate demand. This equilibrium is reached when aggregate demand -AD- equals aggregate supply -AS- because at this level there is no tendency for income and output to change. 

Economists use the AD-AS model to:
Illustrate how aggregate supply and demand change as the economy booms and recedes
Determine the state of the economy
Implement effective strategies to complement economic activity

Related Test: Money, Banking, and Financial Markets Practice Test: Monetary and Fiscal Policy in the IS-LM Model 

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