Aggregate Demand and Supply - Activity

This Activity is designed to be used in the classroom or as a homework task to support the teaching and learning of Aggregate Demand and Supply.

Aggregate Demand and Supply - Activity

This Activity is designed to introduce you to using aggregate demand and aggregate supply models to analyse the impact of external shocks and government policy on the key targets of economic policy.

Models

Models are an important part of economics. They are used to help represent reality as we know it. They help us to be able to investigate what we think might happen if various things change and to make some simple predictions about the future. It is important to remember that models are a form of hypothesis - they are capable of being challenged and amended as time goes on and the depth and quality of information improves. AS and AD curves are no different.

Remember they are simplifications and they will inevitably only tell you a fraction of the total situation. In some cases, you might come across a different result in reality to the one the model predicts. It does not mean that the model is useless but may be that special circumstances have been at work that have amended the outcome. This should be seen as an opportunity for you to think about what some of these factors could be. It will help to improve your understanding and also your critical awareness - i.e. not just taking things at face value!

The Aim

The aim of the activity is to build your confidence and understanding of aggregate demand and aggregate supply and to be able to use the diagrams that are associated with these concepts appropriately.

Your Task

You will be given a list of different scenarios that will have an effect on either aggregate demand or aggregate supply. You should use a diagram to explain what the impact would be and also write a short explanation of the impact. In this explanation, you should try to make some judgements about the relative size of the impact of the changes. The reason for doing this is that many exam boards expect you to be able to evaluate and this means making judgements. Look out for some of the key words in the scenario you are given.

We have produced an example for you below to get you going.


Scenario: A significant increase in world oil prices

Answer: An increase in world oil prices is likely to impact on aggregate supply. This is because oil is an important commodity used in virtually every industry and also domestically. Given the wide-ranging impact, it is likely to lead to an increase in input prices and thus raise costs. The AS curve will therefore shift to the left. This will lead to a rise in inflation from 2.0% to 3.0%. This rise is relatively large and can be explained by the fact that we are told that there is a 'significant' rise in oil prices. As AS shifts to the left, the capacity of the economy falls and we would expect real national income to fall to Y2 and the economy would experience lower economic growth. This, in turn, would suggest that unemployment is likely to rise. If oil prices rise significantly, this increase in unemployment could be relatively large as so much of industry depends on oil for a variety of uses.

Impact of an increase in world oil prices on aggregate demand and supply


Using the example above, try to analyse the impact of the following scenarios. Remember - the scenarios could relate to either or both of AS and AD. It is often easier, initially, to analyse the effect on just one area - just make it clear why you have chosen to use AS or AD. In some cases, the scenario could affect more than one variable. Think carefully about how you would analyse such cases - it is good practice for building a coherent and logical argument.

  • Government announces a large increase in spending on health and education.
  • Chancellor announces tax exemption scheme on new investments for small to medium sized businesses.
  • New regulations on national insurance and pension schemes will increase red tape surrounding employment claims the Confederation of British Industry (CBI).
  • Average wage rises way above inflation for the third month running.
  • Exchange rate appreciation knocks export hopes for manufacturing.
  • Share prices tumble, wiping 20% off company values.
  • Institute of Directors (IOD) latest survey shows clear signs of optimism for the future of the economy.
  • UK productivity levels at their highest level for 10 years.
  • Government 'stealth taxes' increase tax burden to highest level for 50 years.
  • Expansion in numbers of students attending higher education exceeds government targets.
  • Bank of England signals rise in interest rates of ½%.
  • No rate rise in UK but US and EU central banks increase interest rates.
  • Radical reform of welfare spending should help government cut spending as a proportion of GDP.
  • Stability of inflation cheers business leaders.
  • Britain leads the way in nano-technology development - this could be very, very big claims government minister!