Question

a) With lockdowns currently imposed across Europe and North America until mid-April, even in
the best-case scenario it will take at least until mid-June for market confidence to be restored in
these economies. The implication is that nearly six million workers in Bangladesh’s formal sector
– which is largely manufacturing – will be without steady work for an extended period.

Which part of the production function do you think the issue mentioned above will affect? Draw
two diagrams to show Real GDP and LRAS is affected in the long run.

b) “The government should also consider an unconditional cash transfer program for an initial
period of three months at a rate of $95 per month, which corresponds to the minimum wage for
the formal sector in Bangladesh. This would cost the government roughly $14 billion, or 4% of
GDP. While this sort of cash transfer program always suffers from targeting issues, Bangladesh
enjoys a highly sophisticated mobile financial services network, which could improve the cover
of the program. A concerted effort involving the non-governmental organizations working in the
informal sector, mobile financial service providers, and the government could be developed to
deliver this urgently needed social assistance.”

Which type of environment under institutions is the above extract referring to? Explain.

Answer 1

A curve that shows the relationship between price level and real GDP that would be supplied if all prices, including nominal wages, were fully flexible. The price can change along the LRAS, but output cannot because that output reflects the full employment output.

The LRAS represents a point on a country’s PPC, translated into the AD-AS model. Every point on the PPC represents the maximum sustainable capacity for production in an economy. This value of real GDP represents the economy’s maximum sustainable capacity with current stock of resources.

Economic growth means the economy’s potential output is rising. Because the long-run aggregate supply curve is a vertical line at the economy’s potential, we can depict the process of economic growth as one in which the long-run aggregate supply curve shifts to the right. Economic growth can be considered as a process in which the long-run aggregate supply curve shifts to the right, and because output tends to remain close to this curve, it is important to gain a deeper understanding of what determines long-run aggregate supply.

If the economy begins at potential output of Y1, growth increases this potential. The figure shows a succession of increases in potential to Y2, then Y3, and Y4. If the economy is growing at a particular percentage rate, and if the levels shown represent successive years, then the size of the increases will become larger and larger, as indicated.

Figure-1

The position of the long-run aggregate supply curve is determined by the aggregate production function and the demand and supply curves for labor. A change in any of these will shift the long-run aggregate supply curve.

Figure-2 - A, B, C

A-

B

C