Question

Aggregate Demand and Aggregate Supply Assume Broncoland has the following aggregate demand (AD) and short-run aggregate supply (SRAS) schedules.

Price Level	Aggregate Demand	Short-Run Aggregate Supply
120	8250	9700
115	8300	9750
110	8400	9700
105	8500	9600
100	8600	9500
95	8700	9300
90	8800	8800
85	8900	8000
80	9100	7000

Return to the original values of aggregate demand and short-run aggregate supply. Assume the long-run full-employment level of output (often called either potential GDP or the natural rate of output) is equal to 8800. Graph aggregate demand, short-run aggregate supply, and long-run aggregate supply. Remember to label the curves. Also, remember that if the economy is operating at the full-employment level of output, the unemployment rate is equal to the natural rate of unemployment, and the economy experiences full employment of resources. H. Return to the original values of aggregate demand and short-run aggregate supply. Assume potential GDP decreases to 7,000. Graph the aggregate demand curve, short-run aggregate supply, and the new potential GDP. Be sure to describe where the economy is operating in the short-run relative to where we want the economy to operate. Is the economy operating at full-employment? Is the unemployment rate greater or less than the natural rate of unemployment? Inflationary Gaps An inflationary gap exists when the economy is producing a level of output greater than Potential GDP. With an inflationary gap, the short-run level of output produced in the economy is not sustainable. It is greater than Potential GDP; we are operating outside our production possibilities frontier. There are shortages of labor and other resources. These shortages of labor and other resources cause nominal wages and other resource prices to increase. This increases production costs, causing the short-run aggregate supply curve to decrease. The short-run aggregate supply curve will continue to decrease until long-run equilibrium is reached where AD = SRAS = LAS. With that information in mind, do the following: A. Return to the original value of aggregate demand and short-run aggregate supply. Assume long-run aggregate supply increases to 9,500. Graph aggregate demand, short-run aggregate supply, and the new long-run aggregate supply. Remember to label each of the parts of your graph. You should also describe where the economy is operating in the short-run relative to where we want the economy to operate. Is the economy operating at full-employment? Is the unemployment rate greater or less than the natural rate of unemployment? B. Graph an inflationary gap. Graph the decrease in short-run aggregate supply that will move the economy back to long-run equilibrium. Label the second short-run aggregate supply curve SRAS2. Recessionary Gaps A recessionary gap exists when the economy is producing a level of output less than potential GDP. If either an inflationary gap or a recessionary gap exists, the economy does not achieve full employment of resources. Classical School economists believe the economy has a self-correcting mechanism, a natural adjustment process that will take place to move the economy back to long-run equilibrium without any type of government interference. With a recessionary gap, the short-run level of output produced in the economy is less than the full-employment level of output. We are operating inside our production possibilities curve, and labor and other resources are unemployed. Because there is a surplus of labor and other resources, nominal wages and other resource prices fall. This will decrease production costs, increasing the short-run aggregate supply curve. With that information in mind, do the following: A. Graph a recessionary gap. Graph the increase in short-run aggregate supply that will move the economy back to long-run equilibrium. Label the second short-run aggregate supply curve SRAS3.

Answer 1

Answer:

The aggregate demand graph shown as AD is marked in the diagram. The short run aggregate supply curve (SRAS) is also mention. The equlibrium price and output level that is intersection of AD and SRAS is at price level 90 and output level 8800. The potential output is marked as LRAS at 8800 in the above diagram.

If potential GDP decrases from 8800 to 7000, the LRAS shifts leftwards from 8800 level of output to 7000 level of output. The new potential GDP is shown in the graph as LRAS'.  

Due to change in potential GDP now the economy is in short run will too operate at 7000 output level and at 80 price level. Earlier the economy was in short run was operating at 8800 output level and 90 price level.

No the economy is not operating at full employment level. Infact it is below full emplyment level. The full employment level is at 8800 whereas it is operating at 7000.

The unemployment rate is less than the natural rate of unemployment.