Question

Instructions: When responding to the graphically illustrate portion of the question, make sure your axes and curves are properly labeled. When responding to the explain portion, use a flow chart or a narrative, not both. 1. Main: Using the AD-AS Framework, graphically illustrate and explain what happens to the equilibrium price level and equilibrium level of Real GDP in response to an increase in excess capital stock on hand and a reduction in the cost of oil. Follow up: Would you conclude that this combination of events is inflationary? Explain Follow up: Would you conclude that this combination of events is promotes economic growth? Explain

Answer 1

1. The Macro impact of fall in oil prices and rise in excess capital stock can be shown through the rightward shift of Aggregate supply curve. Due to fall in oil prices, the cost of transportation etc. will reduce. The change in capital will also be reflected through shift of AS only. This combination of events causes:

a. Reduction in equilibrium prices.

b. Increase in the equilibrium level of real GDP.

Level. w AD a da quantity / level of GDP (Real) BC Pastire......

This can be shown diagrammatically as follows:

2. This combination of events is not inflationary. This is because this combination of events have actually led to more supply at each price level. This will help increase the equilibrium level of GDP along with Lower equilibrium prices. Hence, this combination is not inflationary.

3. Yes, this combination of events will promote economic growth. This is because more supply at lower level of prices will actually help raise the standard of living of a country as more people will now be able to enjoy the benefits of economic growth.