Question

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13. Suppose the economy is currently in long run macroeconomic equilibrium, with actual GDP equal to potential GDP. (a) Depict this situation using AD-AS, being sure to label all curves and axes. 5 points. The government invests significant resources in building new schools and universities. (b) Depict the effect on prices and output this will have on AD-AS model and the new short run equilibrium (You can use the same graph as in (a) as long as its clear). 5 points. (c) Depict the effect this has in the Keynesian Cross diagram in the short run and tally with the AD-AS diagram. Clearly show all the effects. 5 points. (d) Depict what will happen to prices and output in the long run graphically in the AD-AS model (You can use the same graph as in (a) as long as its clear). 5 points.

Answer 1

Aus 13 Price (8) LRAS AS Po AD O YE Now govt invests university this all as 6 we uses to the cum. Price ($) LRAS AS P , YE coss o in government spending. It is similar to When actual GDP = poteutial GDP. Outpect / Real GDP gost significantly on school and constuction. Impact of follows? Gout expenditur ou social infrastructure as a result AD curve shifts short right in fata (Auswa b) Price level uses to op, whille real GDP rises to potential The actual ADP is greater than oy, in the eco ADP causing e inflationary gap economy Outpect / Real app Keyneslau Az = C+1+4, -AE = ctito y Coutput) YE The oulpet uses by a multiplice effect effect which glven by side of multiple times change the change as depicted in AD-As diagram ( Shuswed) In lov prices and wages long will become flexible sue to excess shout win and higher prices, the workers will a demanding a higher wage This will cause the nal ise and cost of production to increase Producers will now demand less laba a lay off excess one causing output to and thus As curve shifts upward in rum until it reaches poln E ( long equilibrium) where economy operated at full employment level. In this will sell couets in automatic adjustment through variables. It can be shown as below: NOTE : Above analysis is based on the assum will not affect the productive workers efficiency in particular. efficiency of or AB, Y-AE AGT when 4,790 YI es a employment in cate rate to run way, lowering un economic and school construction that university - ption that Price ($) LRAS AS AS /long nury Po should un ADI 0 outpect / Real GDP YE Y, Scanned with CamScanner CS Scanned with CamScanner