Question

1.)

a. Explain the difference between the Long Run Aggregate Supply Curve (Potential Output) and the Short Run Aggregate Supply Curve.

b.  Explain what a recessionary gap is and how the economy self-corrects and returns to potential output.

c. Graph and explain demand pull inflation and Graph and explain cost push inflation.

Answer 1

Answer to first question is provided :

a) The long run aggregate supply curve ( LRAS ) is a vertical line at potential output . In short run firm raise both price and output , when aggregate demand increases . But in long run output reaches potential and there is price change with aggregate demand . In long run due to flexibility of wages and prices , firms have very less incentive to change output , hence it is vertical . In long run potential is reached . But in short run the SRAS is upward sloping curve which depicts the positive relation between price level and real output .  The aggregate supply will differ from potential output in the short run because of inflexible in costs. In the long run, as cost respond to the higher level of prices, most or all of the responses to increased demand takes the form of higher prices — with output remaining fixed at the potential (full employment) level , making LRAS vertical .