Explain: “Unemployment can be caused by a decrease of aggregate demand or a decrease of aggregate supply.” In each case, specify the price-level outcomes.

The change in unemployment can vary with the change in magnitude, mainly decrease in aggregate demand. If the economy is at full employment level, then a decrease in aggregate demand will have an uncertain effect on unemployment but substantially impact the price level. Suppose the economy is operating on the left side of the full employment level, then the reduction in aggregate demand will increase unemployment more than the price change.

Suppose the economy was operating at point A, and after the change in aggregate demand, the economy shifts to point B. Thus, the output falls more than the price change.

When the aggregate supply reduces, the price level will increase; thus, the output will fall. With the fall in production, unemployment will increase as the output is reduced.

As the aggregate supply falls, the economy moves from point C to point D, where the price level increases and the output falls; thus, it creates unemployment.