AP Macroeconomics Page 1 of 6

Test: The AD/AS Model

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Directions

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1. Basics of the AD/AS Model

A. Draw the AD curve and write the equation that shows how AD is measured.
(3 points)

AD=C+I+G+(X−M)
𝐶
C = Consumption (household spending)
𝐼
I = Investment (business spending)
𝐺
G = Government spending
𝑋
−
𝑀
X−M = Net exports (exports minus imports)

B. Describe the three different sections of the AS curve. (3 points)

1. Horizontal (Keynesian) Range: When the economy is below full employment, output can
increase without raising prices. The AS curve is flat.

2. Upward Sloping (Intermediate) Range: As the economy approaches full employment, output
increases but at a higher price level due to rising costs. The AS curve slopes upwards.

3. Vertical (Classical) Range: When the economy is at full employment, further output increases
are impossible without inflation, so the AS curve becomes vertical.

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AP Macroeconomics Page 2 of 6
Test: The AD/AS Model

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C. Describe the short-run effect of a demand shock that increases AD. (4 points)

Consumers will buy fewer goods because they want to protect themselves from future losses due to possible
unemployment. Businesses will undertake less investment, both to protect themselves from future decreases in
profit, and because the decrease in consumption spending by consumers decreases their return on new capital
investments.

D. Describe the long-run effect of a supply shock that decreases AS. (4 points)

The economy begins at full employment on it's long-run AS curve. The increase in AD causes a short-run
increase in RGDP and the price level. However, the higher price level increases wages, and short-run AS
decreases. The final equilibrium returns to the original RGDP, on the long-run AS curve, but at a higher
price level. The increase in aggregate demand ultimately just increases the price level.

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AP Macroeconomics Page 3 of 6
Test: The AD/AS Model

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2. Applying the AD/AS Model

A. A favorable report on the economic outlook improves consumers' feelings

about the economy. What is the short-run effect of this report? (3 points)

In the short run, a favorable economic outlook increases consumer confidence, leading to
higher consumption and increased aggregate demand (AD). This shifts the AD curve to
the right, resulting in higher output and a higher price level.

B. What are the short-run and long-run effects of a sharp increase in the price
of copper due to a sudden worldwide shortage? (3 points)

Short-run effect: A sharp increase in the price of copper raises production costs, reducing aggregate
supply (AS). This shifts the AS curve to the left, leading to higher prices (inflation) and lower output
(stagflation).

Long-run effect: In the long run, the economy adjusts as firms adopt new technologies or find
substitutes for copper. The AS curve shifts back to the right, restoring output to its potential level, but
the price level may remain higher than before.

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AP Macroeconomics Page 4 of 6
Test: The AD/AS Model

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C. With a recession looming, households reduce their spending and increase

their saving. What are the short-run and long-run effects of this? (3 points)

Short-run effect: Reduced household spending lowers aggregate demand (AD), shifting the AD
curve to the left. This leads to lower output and possibly higher unemployment, as businesses
reduce production in response to weaker demand.

Long-run effect: In the long run, lower consumption and higher savings can lead to more
investment, which may boost productivity and economic growth. The AD curve may shift back
to the right, restoring output to its potential level, though the price level may be lower due to
reduced demand.

D. The price of crude oil drops by more than 50% from August to September.
What is the short-run effect of this drop? What would need to happen for
the long-run effect to be the same as the short-run effect? (3 points)
Short-run effect: A significant drop in the price of crude oil lowers production costs for many
industries, increasing aggregate supply (AS). This shifts the AS curve to the right, leading to lower
prices and higher output (economic expansion).

Long-run effect: For the long-run effect to be the same as the short-run effect (i.e., sustained lower
prices and higher output), the decrease in oil prices would need to be permanent. If the price drop is
temporary, the economy may return to its previous equilibrium once oil prices rise again.

E. A country repeals its minimum-wage law. What are the short-run and long-
run effects of this action? (3 points)

Short-run effect: Repealing the minimum wage law may lead to a decrease in wages for low-
skilled workers, resulting in lower income for those affected. Firms may hire more workers at
lower wages, potentially reducing unemployment in some sectors but increasing income
inequality. Aggregate demand (AD) could decrease due to lower consumer spending.

Long-run effect: In the long run, the labor market may adjust with more flexible wages,
leading to a more efficient allocation of labor. However, the impact on unemployment and
income inequality depends on factors like worker productivity, wage bargaining, and broader
economic conditions. Output could increase if lower wages make firms more competitive, but
inequality may persist or grow.

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AP Macroeconomics Page 5 of 6
Test: The AD/AS Model

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3. A country is in a recession. One of the major political parties proposes

significant reductions in both corporate and individual income taxes in order to
end the recession. Explain the rationale behind this proposal. (5 points)

The Federal Reserve’s most primary funtion is to control inflation without

triggering a recession. In additon to that, the Federal govermmetn has
three other less visible, but no less critical,functions, Supervise the
nation;s banking system to protect consumers, Maintain the stabiliy of
the finansial markets and constrain potential cries.

4. Government Spending and the AD/AS Model

A. According to the AD/AS model, what will happen if the government puts
into effect a balanced-budget spending increase? (3 points)

In short run the AD curve will decrease, and the AS curve will decrese. In
the long-run model, the AD will increase, and the AS curve will increase.

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AP Macroeconomics Page 6 of 6
Test: The AD/AS Model

User Name:_______________ Instructor: _________________ Date:__________

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B. In response to calls for education reform, a government increases its

spending on education by $200 billion. If the economy was already at the
full-employment level, what are the short-run and long-run effects of this
spending increase? (4 points)

In the short-run, AS curve will increase, and the AD curve decrease.

In the long-run, the As curve will vertical, the AS curve will decrease.

C. In a country, the unemployment rate at the full-employment level is 3%. A

new government public works program results in massive hiring, reducing
the unemployment rate to 1.5%. Describe and explain the effect of this
change. (4 points)

The full-employment is increase to 4.5%, after the decline of unemployment rate.

The AD cuve will increase, and the AS curve will decrease.

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