Question

Case 1 Automatic Adjustment without government control when

the AD grows slower than LRAS.

•

Case 2 Expansionary monetary policy when the AD grows

slower than LRAS.

•

Case 3 Automatic Adjustment without government control when

the AD grows faster than LRAS.

•

Case 4 Contractionary monetary policy after observing AD

grows faster than LRAS.

Illustrate on the graph every case

Answer 1

Case 1 SRAS, LRAS PL SRAS2 PL2 X - - PL3 ADI - +-+-+ - ΑΟΣ Y Y, GOP This economy is initially in long-run equilibrium. Its current output (Y,) is the same as its full - employment output (Yf). Then, one of the components of AD grows slower than LRAS and it shifts. (1) As a result, output and price level decreases. In the long-run, a decreate in the price level will drive down input prices and expectations about inflation, which leads to the increase in SRAS shown by shift (2). In the long run the price level has decreased but the new output (Y3) is once again equal to the full employment output (44)

PL LRAS SRAS 100 t - - АО go - - - - ADO 400 500 600 700 Real output case 2 The equilibrium is at to where AD arous grows than slower than LRAS at an output level of 600. An expansionary monctary policy will reduce interest rates. and Stimulate investment and consumpton spending, causing the original aggregate demand curre (ADO) to shift right to AD so that the new equilibrium (E) occurs at the potential GDP level 700.

SRAS2 LRAS SRAS, AD2 ADI Y / GPP Case 3. This economy is initially in long-run equili - brium. ats current output (4) is the same as its full employment output (44). Then , one of the Components of Ab increases as shown by shift (I). As a result, co sult, output and the price level increases. An increase in the price level will drive up imput prices and expectations about inflation, which leads to the decreases in SRAS shown by shift (2). on the long run, the price and has increased, but the new culput (43) is once again equal to the full employment Output (Yf).

W LRAS SRAS 120 110 100 - ADO ADI 80 400 500 600 700 800 case 4. The original equilibrium (to) occurs at an output of 750, which is above potential GDP A Contractionary monetary policy will raise intarest rates, discour -age borrowing for Envestment and Consumptron spending and cause the oliginal demand awowe CADO) to shift to CAD,) , so the new equilibrium (6) occurs at the potential App level of 700