Question

IV. Suppose an economy is in long run equilibrium. (a) Use the model of aggregate demand and aggregate supply to illustrate the initial equilibrium on a BIG and clearly labeled graph. Label the equilibrium point A. Be sure to include the short-run and long-run aggregate supply. (b) Household spending increases. Use your diagram to show what happens to output and the price level as the economy moves from the initial to the new short-run equilibrium (label it point B) (c) Now show the new long-run equilibrium (label it point C) on the same graph. What causes the economy to move from point B to point C? (d) According to the sticky wage theory of aggregate supply, how do nominal wages at point A compare to nominal wages at point B? How do nominal wages at point A compare to nominal wages at point C? Explain. (e) According to the sticky-wage theory of aggregate supply, how do real wages at point A compare to real wages at point B? How do real wages at point A compare to real wages at point C? Explain.

Answer 1

(IV.) as SRAS Erice Level V - DD yf 12 Real GDP LRAS The diagram depicts the initial equilibrinon at point L SRAS A where aggregate dernand (AD), short Run Aggregate supply (SRA) and Long Run Aggregate supply Curve (LRAS) intersects. I 6 An increase in the level of Ľ household spending will shift o the AD came right wards to ADI and new short run equilibrium occurs at point & where both price level and real GDP has. increased in the econorry to ope and ove. ic. This reduces unemployment rate and increases bargaining power of workers wis-a- mis employers and thus wage & rate in the economy increases which increases Cost of eduction and shifts & the SRAS nowe leftwards to SRAS!" d new long run equilibrium occurs at point ce Nominal wages at o are lower as compared to ges at point B. At point c the producers have adjusted their adgy supply and thus nominal wages are a equal dat o and "I c. at (d) Nominal nominal wages have