Question

2. Explain whether each of the following events will increase, decrease, or have no effect on long-run aggregate supply. Draw the graph and show your work. (a) The United State experiences a wave of immigration. (b) Congress raises the minimum wage to $15 per hour. (c) Intel invents a new and more powerful computer chip (d) A severe hurricane damages factories along the East Coast 3. Draw a diagram with aggregate demand, short-run aggregate supply, and long-run aggregate supply. Be careful to label the axes correctly. Use the diagram to explain why U.S. has experienced long run growth and inflation.

Answer 1

a) Longrun aggregate supply shows the output level which is equal to the maximum productive capacity of the economy. Thus the longrun aggregate supply is static and it is not influenced by changes in price level. Therefore the longrun aggregate supply curve is represented by a vertical line. But the longrun aggregate supply can change with changes in labour supply and other resources, changes in technology and capital. The immigration in U.S increases the labour supply and the longrun aggregate supply curve shift to the right. The potential output of the economy increase and the economy experience a longrun growth. LRASO LRASI Price GDP The continuous immigration shift the U. S longrun aggregate supply curve to the right from LRASO to LRAS1 which increases the U.S potential output from YO Y1. b) The shortrun aggregate supply curve in influenced by the changes in input prices. In shortrun the increase in minimum wage shift the shortrun aggregate supply curve to the left leading to a huge unemployment. Thus the productive capacity of the economy shrinks which will shift the longrun aggregate supply curve to the left.

LRAS, LRASO. SRASI SRASO YI YOGDP The minimum wage rise shifts the shortrun aggregate supply curve to the left from SRASO to SRASI. The unemployment increase which in turn reduce the productive capacity. The longrun aggregate supply curve shift to the left from LRASO to LRASI. GDP in longrun decrease from YO to Y1. c) The invention of new computer chip increases the productivity. Then longrun aggregate supply curve shift to the right and the economy is able to produce more from the same input. LRASO LRASI YO Y1

The invention of new and productive computer chip by Intel increase the productive capacity and the longrun aggregate supply curve shift right causing the natural level of output increase from YO to Yl. d) The hurricane damages factories in the East Cost. This will reduce the capital stock. The fall in capital stock reduce the potential output. Thus the longrun aggregate supply curve shifts to the left. LRASI LRASO - - - - - - - - - - - - - Yi YOGDP The longrun aggregate supply curve shift to the left and the potential GDP decrease from YO to Y1. 3. Economic growth increases the aggregate demand via increase in income of the people. If aggregate demand increase faster than the rate at which firms can increase output higher economic growth leads to higher inflation. The excess demand and supply constrains push up prices. Due to a rapid growth the unemployment will be low. The firm find it difficult to find additional labour and wage rate increase. The increase in wage conveniently shifts by the firms on the price of the product. With high growth people may expect higher inflation. This inflation expectation rise the resource price and output price. The US economy experiencing a faster inflation than GDP growth since the increase in aggregate demand is greater than the increase in GDP.

LRASO GRASI YO Y1 The economic growth shifts the longrun aggregate supply curve right to LRASI. But the aggregate demand curve shift up from AD to AD1. Thus the price level increase from PL to PL1 while the potential output increase from YO to Y1