Question

Use the dynamic aggregate demand and aggregate supply model and start with Year 1 in long-run macroeconomic equilibrium. For Year 2, graph aggregate demand, long-run aggregate supply, and short-run aggregate supply such that the condition of the economy will induce the Federal Reserve to conduct an expansionary monetary policy. Briefly explain the condition of the economy and what the Federal Reserve is attempting to do.

Answer 1

The short run aggregate  model of aggregate demand and long-run aggregate supply predicts that the economy will eventually move toward its potential output. To see how nominal wage and price stickiness can cause real GDP to be either above or below potential in the short run, consider the response of the economy to a change in aggregate demand.

an economy that has been operating at potential output of $12,000 billion and a price level of 1.14. This occurs at the intersection of AD₁ with the long-run aggregate supply curve at point B. Now suppose that the aggregate demand curve shifts to the right (to AD₂). This could occur as a result of an increase in exports. At the price level of 1.14, there is now.excess demand and pressure on prices to rise. If all prices in the economy adjusted quickly, the economy would quickly settle at potential output of $12,000 billion, but at a higher price level.

The short run aggregate supply curve is a graphical representation of the relationship between production and the price level in the short run. Among the factors held constant in drawing a short-run aggregate supply curve are the capital stock, the stock of natural resources, the level of technology, and the prices of factors of production .

A change price level a produces a change in the aggregate quality of goods and services supplied and is illustrated by the movement along the short-run aggregate supply curve. This occurs between points A, B, and C in figure

A change in the quantity of goods and services supplied at every price level in the short run is a change in short run aggregate supplychange. Changes in the factors held constant in drawing the short-run aggregate supply curve shift the curve.

One type of event that would shift the short-run aggregate supply curve is an increase in the price of a natural resource such as oil. An increase in the price of natural resources or any other factor of production, all other things unchanged, raises the cost of production and leads to a reduction in short-run aggregate supply.