determine the effect on either the aggregate demand curve (is it a rightward or
ID: 1234671 • Letter: D
Question
determine the effect on either the aggregate demand curve (is it a rightward or a leftward shift?), the aggregate short-term supply curve, and the long-term aggregate supply curve (does the upward sloping portions of the SAS curve shift left or right, or does the vertical portion of the LAS curve shift to the right or to the left?). Also determine the effect on the price level, the real output level and employment/unemployment. Provide an explanation and express this graphically using the AS/AD macro model.Show that, starting from a long-run equilibrium, an increase in government expenditures increases output in the short-run but not in the long-run.
Explanation / Answer
The aggregate production function shows that the quantity of real GDP (Y ) supplied depends on the quantity of labor (L ), the quantity of capital (K ), and the state of technology. ? When the wage rate makes the quantity of labor supplied equal the quantity of labor demanded, there is full employment. At full employment, the unemployment rate is the natural rate of unemployment, and the amount of GDP produced is potential GDP. Aggregate supply is the relationship between the quantity of real GDP supplied and the price level. Aggregate supply depends on the time frame. The macroeconomic long run is the period of time necessary for all changes to have occurred so that real GDP equals potential GDP. ? The long-run aggregate supply curve, LAS, is the relationship between the price level and real GDP when real GDP equals potential GDP. The LAS curve is vertical, as illustrated in Figure 7.1. ? Along the LAS curve, both the prices of goods and services and the prices of productive resources change. In contrast, the macroeconomic short run is a period during which some money prices are sticky and real GDP might be below, above, or at potential GDP and the unemployment rate might be above, below, or at the natural rate of unemployment. * This is Chapter 23 in Economics. ? The short-run aggregate supply curve, SAS, is the relationship between the quantity of real GDP supplied and the price level in the short run when the money wage rate, the prices of other resources, and potential GDP remain constant. The SAS curve slopes upward, as illustrated in Figure 7.1. ? Along the SAS curve, only the price level changes; the money wage rate and other resource prices are constant. ? The SAS curve shifts leftward when the money wage rate (or other costs) rise. When the LAS curve shifts, so does the SAS curve. Three factors shift the LAS curve: ? Changes in the full-employment quantity of labor. ? Changes in the quantity of capital, including human capital. ? Advances in technology. C h a p t e r1 0 0 C H A P T E R 7 ( 2 3 ) Short-run aggregate supply changes when the money wage rate or money price of other resources changes. ? A rise in the money wage rate decreases short-run aggregate supply and shifts the SAS curve leftward. It does not shift the LAS curve. ? The money wage rate changers when unemployment differs from the natural rate and when expected inflation changes. ? Aggregate Demand The quantity of real GDP demanded equals the sum of consumption expenditure (C ), investment (I ), government purchases (G ), and exports (X ) minus imports (M ). Aggregate demand shows the relationship between the quantity of real GDP demanded and the price level. As illustrated in Figure 7.2 the aggregate demand curve, AD, slopes downward. It does so for two reasons: ? Wealth effect — A higher price level decreases the amount of real wealth (that is, the purchasing power of wealth), which decreases the quantity of real GDP demanded. ? Substitution effects — An increase in the price level raises the interest rate, which reduces the quantity of real GDP demanded. In addition, an increase in the U.S. price level raises the price of U.S. goods relative to foreign goods.
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