Q2. (25 points) Consider an economy in the United States, starting from the long-run equilibrium denoted...

Q2. (25 points) Consider an economy in the United States, starting from the long-run equilibrium denoted as the point A. Use an aggregate demand and aggregate supply (AD-AS) diagram to show that the economy is in the long-run equilibrium. (Please label variables clearly) a. If the U.S. currency becomes stronger (the value of a dollar increases), there is a change in international variables. How does this situation affect the AD-AS diagram? What will happen to the equilibrium price level and real GDP in the short run? Is the economy experiencing an inflationary gap or a recessionary gap? Explain your answer. (Please write the new equilibrium point denoted as the point B) e. From part (a), how does government use the supply-side effects of fiscal policy to maintain the level of full employment? Please show related concepts graphically.

Expert Solution

(A)

In following graph, initial long-run equilibrium is at point A where AD0 (aggregate demand), LRAS0 (long-run aggregate supply) and SRAS0 (short-run aggregate supply) curves intersect, with initial long-run equilibrium price level P0 and initial equilibrium real GDP (= Potential GDP) Y0.

(a) Stronger US dollar will make US exportable goods less competitive in global market, so export demand falls. At the same time, imports become cheaper, so import demand rises. Lower exports and higher imports will decrease net exports, lowering aggregate demand. AD curve will shift leftward, lowering price level and real GDP, creating recessionary gap in short run.

In following graph, AD curve will shift leftward to AD1, intersecting SRAS0 at point B with lower price level P1 and lower real GDP Y1, with recessionary gap being equal to (Y0 - Y1) in short run.

(b) Government can use expansionary supply-side fiscal policies to increase aggregate supply, which will shift SRAS curve rightward, further lowering price level but restoring real GDP to potential GDP. In above graph, SRAS0 will shift rightward to SRAS1, intersecting AD1 at point C with lower price level P2 but restoring real GDP to Y0, eliminating recessionary gap.

Rahul Sunny answered 2 years ago

Q1. Consider an economy in the United States, starting from the long-run equilibrium denoted as the...

Q1. Consider an economy in the United States, starting from the long-run equilibrium denoted as the point A. Use an aggregate demand and aggregate supply (AD-AS) diagram to show that the economy is in the long-run equilibrium. (Please label variables clearly) a. If the U.S. currency becomes stronger (the value of a dollar increases), there is a change in international variables. How does this situation affect the AD-AS diagram? What will happen to the equilibrium price level, inflation, unemployment and...

Consider the long-run model of a small open economy with perfect capital mobility. Starting from an...

Consider the long-run model of a small open economy with perfect capital mobility. Starting from an initial equilibrium with balanced trade, illustrate graphically and explain verbally how the following (ceteris paribus) events affect saving, investment, and the trade balance in this economy. 1. Foreign governments decide to raise their taxes, causing a change in the world real interest rate

Suppose the economy is in long-run equilibrium.

Scenario 1 - Pessimism Suppose the economy is in long-run equilibrium. Then because of corporate scandal, international tensions, and loss of confidence in policymakers, people become pessimistic regarding the future and retain that level of pessimism for some time. Scenario 1 - Pessimism. Which curve shifts and in which direction? aggregate demand shifts right aggregate demand shifts left aggregate supply shifts right. aggregate supply shifts left.

Consider an economy that begins in long-run equilibrium. Suppose that there is a wave of pessimism...

Consider an economy that begins in long-run equilibrium. Suppose that there is a wave of pessimism that reduces investment demand at any given real interest rate. That is, suppose that the investment demand curve shifts down and to the left. Use the IS-LM diagram and the aggregate supply - aggregate demand diagram to show how this shift down of the investment demand curve affects the interest rate, income, investment, the price level, consumption, and the supply of real money balances...

Consider the economy of a country A working on its long run equilibrium prior to the...

Consider the economy of a country A working on its long run equilibrium prior to the outbreak of COVID-19. Suppose that this country has been badly affected by COVID-19 to date, over the course of past four months, after the first case has been reported. a) By using an appropriate diagram and your knowledge of economics, show the current state of equilibrium in country A. (Refer to the concepts such as aggregate demand curve, short-run aggregate supply curve, long-run aggregate...

Consider the Canadian economy that is in long run equilibrium with output equal to Y*. The...

Consider the Canadian economy that is in long run equilibrium with output equal to Y*. The United States economy goes into a major slowdown causing a significant decrease in goods and services shipped into the United States from Canada. For the Canada, answer the following questions: A) What kind of shock occurred- aggregate demand or aggregate supply? Explain your answer. B) Explain the how fiscal policies by government of Canada can be used to drive the economy back towards Y*...

Consider an economy that initially stays at its long-run equilibrium. Policy affects the economy with a...

Consider an economy that initially stays at its long-run equilibrium. Policy affects the economy with a one-period lag. Answer the following questions: Use the 3-equations model and diagrams to provide a period by period explanation of how a negative aggregate demand shock lead to a deflation trap, where output and inflation are falling without limit. How can the government use fiscal policy to escape the deflation trap? Illustrate with diagrams. Suppose that the current public debt is already quite large,...

Starting with the long-run equilibrium in the aggregate demand and supply (AD-AS) model. Consider the macroeconomic...

Starting with the long-run equilibrium in the aggregate demand and supply (AD-AS) model. Consider the macroeconomic effects of the lockdown measures due to COVID-19. In each part of your answer, please be brief and concise in less than 100 words. You need to make assumption clear, reasonable and explicit if making any. The quality and logic of arguments determine your marks. a)Explain this development in the AD-AS framework in words (Diagrammatic representation not required) c)Fiscal and monetary policy measures can...

Consider an economy that is initially in long-run equilibrium. Unexpectedly, there is a sudden massive decrease...

Consider an economy that is initially in long-run equilibrium. Unexpectedly, there is a sudden massive decrease in house prices. a) Explain why this is likely to lead to a reduction in private consumption. Theoretically, could consumption also increase? Explain. (3 points) b) Show in the AS-AD diagram, and explain, the consequences of this decline in consumer spending. (3 points) c) If the central bank does not change its monetary policy rule, how will it react to the situation in (b)?...

Consider the AS-AD model where the economy is not in long-run equilibrium, in particular, assume there...

Consider the AS-AD model where the economy is not in long-run equilibrium, in particular, assume there is a negative output gap (that is, the economy is in a recession). (a) Describe the adjustment under fixed exchange rates if there is no government intervention. (b) Contrast your answer with that under flexible exchange rates

Question