Question

In: Economics

ECO - 252 -- Macroeconomics 2. For each event a, b, and c below, use the...

ECO - 252 -- Macroeconomics

2. For each event a, b, and c below, use the AD-AS Model to answer the following 5 questions (in that exact order). Be neat! Do not clump all your answers together. If your answers are difficult to follow because of a messy layout, you will lose points even if your answers are correct.

1) Which curve in the AD-AS model shifts?
2) What is the direction of the shift (left or right)?
3) What are the short-run effects on output, the price level, and unemployment?
4) How will the economy get back to its long-run equilibrium if policy makers take no action? Be thorough!

5) What are the long-run effects on output and the price level?

a. Households decide to save a larger share of their income and to spend less on current consumption.

b. Crops suffer from a prolonged bad weather that promotes the spread of parasites on fruits and vegetables.

c. Europe experiences a huge economic boom.

Solutions

Expert Solution

a) As the households are saving a large part of their income the demand in the economy will decrease.

This will shift the aggregate demand curve to the left at a lower price and lower output in the economy.

A lower output will increase the unemployment in the economy.

In the long run due to increased unemployment, the wages will fall and there will be a positive supply shock in the economy and the supply curve will shift to higher output and lower cost. Bringing long-run equilibrium back in the economy.

b) Crops failure will increase the prices of the products and this will lead to a leftward shift in the aggregate supply curve. The prices will increase and output will fall down. A lower output the unemployment will rise.

In the long run, the wages will increase to match the increased price of goods in the economy and at higher wages, the income will rise and people will demand more and economy will be back at long-run equilibrium.

c) Due to an economic boom, the demand in the economy will rise. The aggregate demand curve will shift to the right at a higher price and higher output. The unemployment will fall at higher output.

In the long run, the wages will increase to match the higher prices and demand and the input cost will increase raising the prices and reducing the demand. The economy will be back at equilibrium at a higher price but same output.  


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