QUESTION 1 - complete the sentences by selecting of the available options In the

Question

QUESTION 1 - complete the sentences by selecting of the available options In the short run, the aggregate supply curve is_Tupward sloping/ downward sloping/vertical] because wages are sticky and, therefore, firms increase their output when the price level increases wages are flexible and, therefore, output is independent of the price level o o upward sloping/ downward sloping/vertical] because wages are sticky and, therefore, firms increase their output when the price level increases wages are flexible and, therefore, output is independent of the price level o o Aggregate demand is_Tupward sloping/ downward sloping/vertical] because as the price level rises, exports decrease due to the international trade effect as the price level rises, interest rates and investment increase o o

Explanation / Answer

(a)

Wages tends to be sticky in short-run. They do not change as price level changes and thus cost of production of firm remains same but their profit-margin increases prompting them to increase production and supply.

Due to this, short-run aggregate supply curve is upward sloping.

So,

In the short-run, the aggregate supply curve is upward sloping because wages are sticky and, therefore, firms increase their output when the price level increases.

(b)

In long-run, wages tends to be flexible and each change in price level brings the change in wages as well. Thus, production of firms remain independent of price level. Due to this, long-run aggregate supply curve is a vertical straight line.

So,

In the long-run, the aggregate supply curve is vertical because wages are flexible and, therefore output is independent of the price level.

(c)

Aggregate demand and price level has inverse relationship. This results in downward slope of aggregate demand curve.

So,

Aggregate demand is downward sloping because as the price level rises, exports decrease due to the international trade effect.

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