The response to the increase in APA is depicted in the figure below.
The line is seen to shift leftwards and repositions the IS line such that the IS curve and the APE line continue intersecting at the original GDP line. Since the decrease in need for funding the APA is matched with an increase in the funding by the nation’s producers, hence the requirement for funding remains equal to the ASF supply. The present situation is APE< GDP = ASF. There would a response from the producers by decreasing unemployment, reduction in prices and output. This will make the ASF line to move rightwards and the GDP and APE line to move leftwards. The economy attains a position which is shown in the figure. This process generates negative economic projects. The shrinkage in industries responding to the negative profits helps the economy move into a position of long run sustainable equilibrium (Ashby, “Case #4 – Demand-Caused Recession”).
This case is just opposite to the above case where there is decline in the funding supply (ASF). All decreases in the ASF includes a reduction in M x V in comparison to the price index (p). During the phase, the rates of interest would be rising, tracking the point of intersection of ASF and GDP lines as they move up across the IS line. The rates of interest would remain below its original level unless and until substantial concessions on costs are able to allow profitable operations at low prices which consequently compensate for the loss in output and unemployment. The fall in the supply of funds of the country (ASF) would trigger a dramatic rise in the interest level because producers would react to the fall in sales. This would be done by the price-output adjustment which involves deflation, output, employment, interest rates and profits, until the equality is restored among the ASF, APE and GDP lines. Output and employment are expected to continue declining unless and until profits and prices rise to their original levels. The process will end with the fall in employment and output levels, rise of interest rates and thus unchanged outputs and profits (Ashby, “Case #5m – Money-and-Credit-Caused Recession”). The figure below would depict the cost push inflation. Due to a wide spread increase in the costs of production, the profit levels, employment levels and output levels would fall. This would be accompanied with the rise in the interest levels in the nation. The employment and output would continue to fall unless and until the negative economic profits can be eliminated completely and successfully. This would happen by allowing the reduction of output till the level that prices rise by the amount equal to the increase in cost (Ashby, “Case #5c - Cost-Push Inflation”). Growth problem in the economy can be explained in the diagram below. It is seen from the diagram that an increase in the output would be followed by an increase in the rates of interest. Producers would immediately react to the low demand in the economy. The rates of interest would fall along with the employment and output levels until they reach their original positions. Since the initial fall would be compensated by an offsetting rise in price levels, they would be maintained at the original positions. After returning to the original position, the economy would suffer a shock which would push down the levels of output, employment and rates of interest below their original positions leaving the price levels at their unchanged positions (Ashby, “