Question

1.         Using the Aggregate Demand-Aggregate Supply logic of Chapter 10, suppose that at first, the economy is at long-run equilibrium, on both the short-run and long-run aggregate supply curves (in other words, unemployment is at the Natural Rate of Unemployment). Then, government spending rises with no change in taxes.   

A.        What happens in the short-run to output (Y) and the prices of goods?

Explain why using Aggregate Demand and Supply logic (you don’t need to draw the graphs unless you want to).

B.        In the short-run, is there a surplus or a shortage of goods? Is there a surplus or a shortage of labor? (No need to explain)

C.        Because of the shortage/surplus in part B, what happens to the prices of goods as we move beyond the short run toward the long-run? What happens to the wages of workers? (no need to explain)

D.        In the end, in the long-run, will the prices be higher, lower, or equal to what they were before anything changed? In the end, will unemployment be higher, lower, or equal to the Natural Rate of Unemployment? Explain your answer.

Answer 1

Suppose economy is long run equilibrium on both short run and long run aggregate and short run aggregate supply curve and aggregate demand curve and which determines P* level of price and potential output level Y *at natural level of unemployment.

Then government spendinh rises with no change in taxes

1. As government spending rises, aggregate demand for good and services will increase. Because government spending drives private investment. It will provide a wide range of job opportunities. As a result, income level rises and iy leads to increase in consumption. Thereby it boost aggregate demand increases in the economy. It leads to rise in general price level in the economy. Aggregate demand curve shows the total demand for good and services in the economy.

b.In short run, there will be shortage of good and services due to increase in aggregate demand for good and services along with constant aggregate supply. There is a shortage of labor. Becauee increase in aggreagate demand forces form to increase the production. It will increase the labor demand.

c. Due to shortage of good and services, price of goods and services will rise as we move beyond the short run toward the long run. Due to higher labor demand, wage of workers will increase.

d. In long run prices will be higher due to higher aggregate demand for good and services. In the end unemployment wilk be equal to natural rate of unemployment

Because labor demand and labor wage increases. As a result labor supply will increase. It will increase the production level in the economy