Question

LRAS SRAS Price level (base year = 1.00) ADAD, AD $11,600 11,800 12,000 12,200 12,400 12,600 Real GDP (billions of base-year dollars) per year 1. Describe why point B is the most desirable point on the graph. What is happening to unemployment at point 2. Point C describes what type of gap? What is the problem with unemployment at this point? Which point on the graph is likely to describe the economy in 2008 - 2009? 3. If unemployment persists and there is a very slow adjustment in the aggregate demand or in the short run aggregate supply, what would occur if the government increased its expenditures on goods and services to stimulate the economy? 4. Are there disadvantages to this government policy? 5. If there were a short run increase in technology and its application to production, what would happen to the short run supply curve?

Answer 1

Answer 1:

Point B is the most desirable point in the above graph because economy is at its potential level because aggregate demand = short run aggregate supply = long run aggregate supply. The unemployment is equal to its natural level when the economy is at full employment level.

Answer 2:

Since actual output at point C is lower than potential level of output, thus it describes recessionary gap in the economy. Unemployment is higher than its natural level at point C. Point C describes the situation of the economy in 2008-09 when the economy was in recession.

Answer 3:

If the government increases its expenditure to stimulate the economy, then the aggregate demand in the economy will shift rightwards to AD1 and the equilibrium will move from point C to point B where recessionary gap in the economy is eliminated.

Answer 4:

It leads to increase in the price level and crowding out impact by increasing rate of interest in the economy which reduces private investment in the economy.

Answer 5:

This will shift the short run aggregate supply curve of the economy rightwards.