Question

8. Economic fluctuations I 

The following graph shows the economy in long-run equilibrium at the expected price level of 120 and the natural level of output of $600 billion. Suppose a stock market boom increases household wealth and causes consumers to spend more. 

Shift the short-run aggregate supply (AS) curve or the aggregate demand (AD) curve to show the short-run impact of the stock market boom. 

In the short run, the increase in consumption spending associated with the stock market expansion causes the price level to _______  the price level people expected and the quantity of output to _______   the natural level of output. The stock market boom wil cause the unemployment rate to _______ the natural rate of unemployment in the short run. 

Again, the following graph shows t before the increase in consumption spending associated with the economy in long-run equilibrium at the expected price level of 120 and the natural level of output of $600 stock market expansion.

 During the transition from the short run to the long run, price-level expectations will _______ and the _______ curve will shift to the of the_______ .

Now show the long-run impact of the stock market boom by shifting both the aggregate demand (AD) curve and the short-run aggregate supply (AS) curve to the appropriate positions.

In the long run, as a result of the stock market boom, the price level _______  ,  the quantity of output  _______  the natural level of output, and the unemployment rate _______ the natural rate of unemployment.

Answer 1

Stock market boom will increase the income and wealth so that AD shifts to the right in the short run. This increases the price and real GDP in the short run.

240 AS 200 AD 160 AS 120 80 AD 40 200 400 600 800 1000 200 OUTPUT (Billions of dollars)

In the short run, the increase in consumption spending associated with the stock market expansion causes the price level to be more tham the price evel people expected and the quantity of output to rate tobe less than the natural rate of unemployment in the short run. e more tha the natural level of output. The stock market boom will cause the unemployment Again, the following graph shows the economy in long-run equilibrium at the expected price level of 120 and the natural level of output of $600 billion, before the increase in consumption spending associated with the stock market expansion Increase During the transition from the short run to the long run, price-level expectations will and the Aggregate supply curve will shift to the Leit

In the long run, since price level has risen, the wages will rise in future and this shifts the AS curve to the left

240 AS 200 AD 160 AS 120 80 AD 40 200 400 600 800 1000 200 OUTPUT (Billions of dollars)

In the long run, the price level has increased, output is equal to natural level and unemployment rate is also equal to its natural rate.

Answer 2

Ans

1 price level rises above... as AD shifts rightwards

2 output rises.... Because AD shifted rightwards(see AD1)

3 unemployment rate then falls because greater output requires greater use of labour

4 price level expectations rise because actual inflation was more than anticipated

5 AS curve will shift leftwards (see AS dash in figure) because labour demands higher wages as price increases their real wage