Question

1.If the price level in the current period is higher than what buyers and sellers anticipated, what will tend to happen to real wages and the level of employment? How will the profit margins of business firms be affected? How will the actual rate of unemployment compare with the natural rate of unemployment? Will the current rate of output be sustainable in the future?

5. (a) What is the difference between the real interest rate and the money interest rate?

(b) Suppose that you purchased a $5,000 bond that pays 7% interest annually and matures in five years. If the inflation rate in recent years has been steady at 3% annually, what is the estimated real rate of interest? If the inflation rate during the next five years rises to 8%, what real rate of return will you earn?

6. How is a nation’s trade balance related to its net inflow of foreign capital? If the inflow of foreign capital is used to finance the federal deficit, how will the well-being of future generations be affected?

Answer 1

The aggregate supply curve depicts the positive relationship between the quantity supplied and the aggregate price in the economy. In the short-run supply curve, the capital is fixed and labor is variable. But in the long run, both capital and labor can vary. The long-run supply curve gives the potential output of the economy that can be produced given the efficient use of its resources.

An unanticipated rise in price due to stronger demand will increase the profit of the producers. The producer will have the incentive to expand their business which will lead to an increase in output in the economy. The producer will employ more labor to increase production. So, unemployment will fall below its natural rate. The rise in price will reduce the real wage.

Unemployment that is natural to the economy due to lack of information and structural changes. This is an unemployment rate that sustains in the long run and the output that is produced at this level of unemployment is called full unemployment output or potential output in the economy. The actual rate of unemployment falls below this rate when the unanticipated inflation expands production.

This rate of output will not be sustainable in the long run because prices of the goods and services will change in the long run. This will increse the cost of production and the profit level will be back to normal. The output level will be back to potential level.