Question

7 Consider a typical aggregate demand and supply curve of an economy operating at its long-run equilibrium. Express the condition for long-run equilibrium and graphically show the long- run equilibrium of this economy in an AD-AS diagram. Explain and graphically show how a positive AD shock affects the short-run equilibrium of this economy. How do the price level and rGDP change in the short term as a result? a. b. Does the positive AD shock result in a recessionary gap or an inflationary gap? Explain and clearly indicate the size of the gap. What does this short-term output gap imply in terms of the rate of usage of factors of production compared to the normal rate indicated by potential output higher rate of usage or lower than the normal rate? How does rate of usage of factors of production you indicate in part (d) impact the price of factors of production? What does the impact you identify in part (e) imply in terms of the unit cost of production for firms? What does the impact you identify in part (f) imply in terms of the profits of firms if the price of their product, quantity of production, and amount of factors of production they use for production remain constant? To remain as profitable as before, firms should increase their price at all levels of production level in response to the impact that you identified in part (f). What does it mean in terms of the position of the aggregate supply curve? c. d. e. f g h. on their unit-cost of production

Answer 1

The long of the run equilibrium economy is LRAS SRAS Anflationary A-7) a condition ginen by AD = SRAS= LRAS where And for the diagram, og I paint represents the long run equilibrium ur the economy (b) o positive AD shock will stuft the Real GoP. x AD curve of the economy right wards to As' and this new short run equilibrium occurs at point Eq where both price level and real GOP has increased in the economy. to ope and oye respectively. is. A positive AD shock results d inflationary gap in the economy because the neue actual lend of Output at 072 í greater than potential lend of Ontbut at of and thus, Yn y represents inflationary gas in the economy. -d since the Output produced by the economy iu greater than the potential level of output of the economy rate this of usage of factors of production is to higher than the normal rate.