Question

Update the graph below to show an increase in short run aggregate supply and show what effect this increase in increase short run aggregate supply will have on price levels and real GDP. 1. Price level SRAS AD Real GDF 2. Assume that a recessionary gap currently exists. If long-run supply (aka, potential output) increases and there is no change to aggregate demand or short run aggregate supply what happens to real GDP and to the recessionary gap?

Answer 1

Answer

1)

We can see from figure below that increase in agregate supply will shift SRAS curve to the Right and at previous equilibrium quantity, now there will be excess short run aggregate supply which will force price level to decline which further results in decrease in quantity of SRAS and increase in quantity of AD and this will continue till SRAS and AD both equalize.

Hence, Overall impact will be decrease in Price level and Increase in Real GDP.

Price SAAS A-D 500 2 LRAS

From Figure above it is clear that increase in potential output will shift LRAS curve to the right. Long run GP is that amount where AD intersects Potential output and hence in the Long Run Real GDP = potential level of output.

Recessionary gap occurs when Potential GDP > short Real GDP and

Hence Recessionary Gap = Potential GDP - short Real GDP

As we can see from above figure that rightward shift of LRAS curve results in increase in Potential GDP and hence difference between Potential and Short Run real GDP increases and hence Recessionary Gap will increase.