Assume the aggregate supply relationship (between output and the price level) in

Question

Assume the aggregate supply relationship (between output and the price level) in a particular economy takes the following form, where all variables are represented as logs; EQU-1' is; y2 = c - d (w - p) where y2= level of output, p= price level, c & d are positive constants (i.e. c>0, d>0) w is the fixed value of the nominal wage and where c0), a1,j (where j=1,2) are coefficients indicating the input of each policy instrument on aggregate demand, and a1,j > 0 (where j=1,2) The question is; using EQU-1 & EQU-2 above to solve for equilibrium values of p & y in terms of the settings of g and m, the a ('subscript' 1,j) and the other model parameters. Also identify these relationships as equations EQU-3 and EQU-4.

Explanation / Answer

1a. False, the SRAS curve is upward sloping indicating a positive relationship 1b. False, the LRAS assumes the real wages are fixed 1c. True 2. Inflation in the short run increases demand leading to a rightward shift of the AD curve along the SRAS curve. In order to meet this short run increase in demand companies hire workers and unemployment falls. Falling inflation in the short run reduces AD and causes a leftward shift of the AD curve along the SRAS curve. 3. A. Quantity and quality of natural resources, B. Quantity and quality of human capital, C. Stock of capital, D. Technology 4. AD-AS-LRAS curves all intersect at point A in 1990. In 2005, AD-AS intersects to the right of LRAS curve at a price level 50% above that of point A, this is point B.

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