Question

For the following changes in an economy, using an LRAS-AD-SRAS framework, tell whether short-run aggregate supply or long-run aggregate supply will be affected. Also, indicate the direction of the change in short and long run, effect on price, unemployment and real GDP. Assuming the economy is at the long run equilibrium explain in text and with a graph. (draw a new graph for each question)

a. Department of Homeland Security implements new policy restricting immigration.

b. A favorable supply shock (decline in the price of oil)

c. New shale deposits are found in North Dakota.

d. A category 3 hurricane damages orange plantations in Florida.

e. The stock of capital in the economy increases.

Answer 1

Answer:

(a) Restriction on immigration

Immigration refers to the influx of people from foreign countries into domestic country. As the Department of Homeland Security implements a policy where restrictions are imposed on immigration, there will be a decline in workers in the economy.

This will reduce the quantity supplied of goods, and services in the economy.

The short run aggregate supply curve will shift to the left.

Refer to the figure below:

• As the shirt run aggregate supply curve will shift to the left, there will be a rise in the price level.
• There will be inflation in the economy.
• The output level will fall.

(b) Favourable supply shock

The supply shock in the economy leads to change in the supply of goods, and services in an economy.

In the given case, a decline in price of oil will reduce the cost of production, and will lead to a positive supply shock.

The positive supply shock will lead to a rightward shift of the short run aggregate supply curve, as more quantity of goods, and services will be produced.

Refer to the figure given below:

• The short run aggregate supply curve will shift to SRAS'.
• The new equilibrium will be at B.
• The income level will rise, and the price level will fall.

(c) Discovery of new shale deposits

As new deposits are shale are discovered, this shows that there is an increase in the productive capacity.

The increase in productive capacity increases the full employment level, and the potential level of output in the economy.

As more deposits are found, the long run aggregate supply of the economy will be affected. This will shift the vertical long run aggregate supply curve to the right.

The short run aggregate supply curve will also shift to the right.

Refer to the figure below:

• The discovery will shift the long run aggregate supply curve, and the short run aggregate supply curve to the right.
• The new equilibrium will be at B.
• The output level will rise, and the price level will fall.

(d) Damage of orange plantations in Florida

The damage of the plantations in Florida will result into a decline in the supply of oranges in the economy. This will affect the production of various goods, which use oranges as raw material, thereby resulting into a decline in the aggregate supply in the economy.

The short run aggregate supply curve will shift to the left.

Refer to the figure below:

• This destruction of crops will shift the short run aggregate supply curve to the left.
• At new equilibrium the price is higher than before, and the output level is low.

(e) Increase in the stock of capital

The long run aggregate supply curve is vertical at the potential level of output. As more stock of capital is added in the economy, there is an increase in the productive capacity.

This increases the level of output which the economy can produce.

This will increase the full employment level, and the long run aggregate supply curve will shift to the right.

The short run aggregate supply curve will also shift to the right.

Please refer to the figure below:

• ​​​​​The new equilibrium will be at B.
• The long run aggregate supply curve will shift to LRAS'.
• The short run aggregate supply curve will shift to SRAS'.
• The new output level will be Y".