Question

The following table shows the initial level of aggregate demand (AD) and te supply (AS) for the economy of Adanac.

The following table shows the initial level of aggregate demand (AD) and te supply (AS) for the economy of Adanac. The full-employment level of output is $500 billion. 

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 a. Draw the corresponding initial aggregate demand and aggregate supply curve (AD0 and AS0).

 b. What is the initial equilibrium price level and level of real GDP? 

 c. At this initial equilibrium (ADand AS0), is Adanac experiencing either a recessionary or inflationary gap? If so, how large a gap exists?

 d. Suppose the aggregate demand in Adanac declines for $125 billion at every price level. In the above table, compute the new quantity of aggregate demand in the column labelled AD1. Add ADto the diagram from part (a). What is the new equilibrium price level and quantity of real GDP?

 e. At the new equilibrium (AD1 and AS0) is Adanac experiencing either a recessionary or inflationary gap? If so, how large a gap exists?


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Answer #1

a) Initial AD and AS are drawn below

b) The equilibrium real GDP is $500 billion and the price index is 110.

c) There is no output gap because current level of short run equilibrium GDP matches the long run equilibrium GDP at $500 billion

d) The graph is drawn below. New equilibrium real GDP is $450 billion and the price index is 100.

e) It is experiencing a recessionary gap of $50 billion since current GDP is $450 billion while potential GDP is $500 billion.

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