Use the dynamic model of aggregate demand and supply to illustrate a situation where aggregate demand and short-run aggregate supply are both increasing from year 1 to year 2, resulting in a higher price level and higher level of real GDP at

macroeconomic equilibrium in year 2.

What will be an ideal response?

AD1, SRAS1 and LRAS1 all represent year 1. AD2, SRAS2 and LRAS2 all represent year 2. Beginning at point A, AD1 shifts to the right by more than SRAS1 shifts to the right. LRAS1 shifts to the right because of the long-run growth in the economy. However, it shifts by less than the aggregate demand curve. The graph also shows the short-run aggregate supply curve shifting to the right by a horizontal distance that is a relatively smaller amount than the aggregate demand curve shift. As a result, the economy ends up at a final equilibrium at point B, with a higher price level (P2 ) and a higher level of real GDP (Y2).