Question

1. Use a fully labelled 2-dimension graph to depict aggregate demand and aggregate supply model. You MUST show the short, medium, and the long-run supply curves, and state the reason for the shapes. (10 POINTS) 2. Use a fully labelled 3-dimension graph to depict the USA economy in business cycles. You MUST show and explain the: full employment level, business cycles, booms, busts, inflation and recession (using AD, AS, and symbol >). On the business cycles, show and label the effect of fiscal policy.
please do both questions

Answer 1

In short run both the aggregate demand and aggregate supply curve are in the shape of rectangular hyperbola. Short run aggregate demand curve is downward sloping with a negative relation between output and price level. On the other hand, supply curve is upward sloping with a positive relation between price and level of output. In short run all the capacity were not used. Short run AD-AS model; Price level D P* S Y* Output In medium run AS-AD model, equilibrium output is equal to natural level of output and the price level is equal to the expected price level. In medium run, the monetary expansion will shift the AD curve to right. Price level AS P=P AD' AD Y=Yn Output Here Yn and pe are the medium run price and output. Due to money expansion the AD cure shift right. The new equilibrium point is E' were at this point Y>Yn and P>pº Where E' is the short run equilibrium. In medium run the money is neutral and the change in price level will

not affect the output level. In long run, the AS curve is vertical and inelastic in nature. The output remains same in different prices. The potential output which can be produced is not related to price level. There is full employment output is produced in long run. But the aggregate supply curve is downward sloping Price LRAS P* AD Y* Output If there is business cycle expansion through certain polices. This can be depicted through a three dimensional diagram; Price P1 P1 P* P* P2 P2 PC Output U2 unemployment rate Here P*, Y* and U* are the potential price, output and unemployment. If the economy move from P* to P1, there is a chance for inflation and economy will lead to recession. High inflation will reduce the aggregate demand and retards the economic growth. On the other hand, the fall in price level will increase the aggregate demand and output. In case of unemployment, Philips curve is shown in the second diagram, where the inflation rises will leads to fall in unemployment rate. This will lead to economic recession and the mild inflation may help the economy to move towards the boom.