Impact of unanticipated change in aggregate demand and supply

Impact of unanticipated decrease in AD :
In short run,

• Unanticipated decrease in aggregate demand => excess supply of resources => decline in resource prices & increase unemployment => decline in price and output

In long run,

• Lower resources costs => shift aggregate supply to the right => produce at the level of output consistent with full employment but at a lower price level

Impact of unanticipated increase in AD
In short run,

• Unanticipated increase in AD => output level greater than that with full employment => less unemployment than the "natural rate" of unemployment => upward pressure on resource prices and interest rates (modified contract)

In long run,

• Higher resources prices and interest rate => shift AS => output decline to what is consistent with full employment.=> decrease in aggregate demand => no change in output but increase in price.

A new market equilibrium will occur at a higher price level. So in the long-run, inflation (higher prices) will be the major effect of the increase in aggregate demand .

Impact of unanticipated Dncrease in AS:
In the short-run,

• Unanticipated decrease in AS => lower the availability of resources => increase in resource prices => shift the aggregate supply curve of goods and services to left => reduce level of output and higher prices.

In long-run,

• For temporary shock, no change in price and output.
• For permanent shock, shift the LRAS to the left, the economy would produce a lower level output at higher prices.

Impact of unanticipated increase in AS
In short-run,

• Unanitipated increase in AS => shifit SAS to the right => increase output and price => increase employment => increase income => increase savings if the income increse is temporary => increase supply of loanable funds => decrease real interest rate.

In Long-run

• For temporary shock - LR-all return to pre-shock levels
• For permanent shock - LR – all remain at post-shock levels