For each question, suppose that the economy begins at the long-run equilibrium p
ID: 1214216 • Letter: F
Question
For each question, suppose that the economy begins at the long-run equilibrium point A in the diagram below. Identify which of the other points on the diagram-points B, C, D, or E-could represent a new long-run equilibrium after the described events take place and move the economy away from point A. (See page 232.) Significant productivity improvements occur, and the quantity of money in circulation increases. No new capital investment takes place, and a fraction of the existing capital stock depreciates and becomes unusable. At the same time, the government imposes a large tax increase on the nation's households. More efficient techniques for producing goods and services are adopted throughout the economy at the same time that the government reduces its spending on goods and services.Explanation / Answer
a. Improvement in productivity shift the AS curve rightwards. Keeping the price level same, equilibrium is attained at B.
b. Increase in tax shifts the AD curve leftwards from AD1 to AD3 and depreciation of capital stock shifts the AS curve leftwards from LRAS1 to LRAS3. New equilibrium is attained at D.
c. Use of efficient technology increases AS and shifts the LRAS1 to LRAS2 and when reduction in spending of government shifts the AD curve leftwards from AD1 to AD3. Intersection of LRAS2 and AD3 determines the new equilibrium point i.e. E.
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