a. Consider the information above. Suppose that G increases by G = 150 units. Wh

Question

a. Consider the information above. Suppose that G increases by G = 150 units. What will be the short-run effects on P and Y?

P in short run =  

Y in short run =  

Description 1. The graph above shows the AD/LRAS/SRAS functions for a country. 2. In the short run, wages and prices are sticky due to contracts, but they fully adjust to market conditions in the long run. 3. Marginal propensity to consume is MPC 0.75 4. Okun's coefficient equals a- 2 5. Currently all the markets are in equilibrium 6. There is no foreign trade and so net exports equal zero 7. Currently the government purchases equal G 1,000 units. 8. All the questions refer independently to this baseline scenario. 9. The short-run effects of a policy or an event on P and Y are defined as the values of these variables after the AD function shifts but before the SRAS function begins shifting.

Explanation / Answer

Using the multiplier effect, we know that change in Y divided by change in G = (1/1-MPC) = (1/1-0.75) = 1/0.25 = 4
So, change in Y = Change in G*(4) = 150 * 4 = 600
New Y - actual Y = 600
So, New Y = 600 + actual Y = 600 + 10,000 = 10,600
Y in short run = 10,600

price corresponding to new Y (i.e. 10,600) on the short run AS curve is 130.
P in short run = 130

In short run, P increases from 100 to 130 and Y increases from 10,000 to 10,600.

P in short run = 130
Y in short run = 10,600

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