A student was asked to draw an aggregate demand and aggregate supply graph to illustrate the effect of an increase in aggregate supply. The student drew the following graph:

The student explains the graph as follows:
An increase in aggregate supply causes a shift from SRAS1 to SRAS2. Because this shift in the aggregate supply curve results in a lower price level, consumption, investment, and net exports will increase. This change causes the aggregate demand curve to shift to the right, from AD1 to AD2. We know that real GDP will increase, but we can't be sure whether the price level will rise or fall because that depends on whether the aggregate supply curve or the aggregate demand curve has shifted farther to the right. I assume that aggregate supply shifts out farther than aggregate demand, so I show the final price level, P3, as being lower than the initial price level, P1.
Explain whether you agree with the student's analysis. Be careful to explain exactly what-if anything-you find wrong with this analysis.

Transcribed Image Text:

Price level SRAS, SRAS, P2 AD2 AD, Real GDP P.