Question

1.1 Four (4) other factors that can have a similar effect on total output and general price level as the identified shock on the economy; these factors must be identified and explained

Answer 1

TOTAL OUTPUT

In economics, total output refers to the amount of final products created in a country. Total output can be measured two ways: as the sum of the values of final goods and services produced and as the sum of values added at each stage of production. GNP is the measure of output typically used to compare incomes generated by different economies.

Total Output (Y) = total output is basically all the goods produced and sold in a country, i.e. aggregate supply of goods (AS). It is simultaneously a measure of all income received and all spending in an economy. It is normally measured by GDP. GDP = Gross domestic product = the money value of all final goods and services produced and sold within a country in a given period of time (usually one year). It is a measure of total output (= total income = total expenditures.

GENERAL PRICE LEVEL

The general price level is a hypothetical measure of overall prices for some set of goods and services, in an economy or monetary union during a given interval, normalized relative to some base set. Typically, the general price level is approximated with a daily price index, normally the Daily CPI.

CPI (Consumer Price Index) = The Consumer Price Index is a measure of the cost of a representative bundle of goods bought by a typical urban household in an economy relative to its cost in some base period. It is a common measure of the "price level". Bureau of Labor Statistics (BLS) (a division of the Dept. of Labor) collects the official CPI data.

Economic Shock

An economic shock refers to any change to fundamental macroeconomic variables or relationships that has a substantial effect on macroeconomic outcomes and measures of economic performance, such as unemployment, consumption, and inflation. Shocks are often unpredictable and are usually the result of events thought to be beyond the scope of normal economic transactions. Economic shocks have widespread and lasting effects on the economy, and are the root cause of recessions and economic cycles in Real Business Cycle Theory.

Economic shocks can be classified as primarily impacting the economy through either the supply or demand side.

Supply Shocks : A supply shock is an event that makes production across the economy more difficult, more costly, or impossible for at least some industries.

Demand Shocks : Demand shocks happen when there is a sudden and considerable shift in the patterns of private spending, either in the form of consumer spending from consumers or investment spending from businesses

Financial Shocks : A financial shock is one that originates from the financial sector of the economy.

Policy Shocks : Policy shocks are changes in government policy that have a profound economic effect. The economic impact of a policy shock might even be the goal of a government action.

Technology Shocks : A technology shock results from technological developments that affect productivity.

AD( Agrregate Demand ) shocks, such as changes in consumption, investment, government spending, or net exports, and supply shocks such as price surprises that impact SRAS (Short Run Aggregate Supply Curve ), and how changes in either of these impact output, unemployment, and the price level.

Demand shock	impact on rGDP	impact on unemployment	impact on price level
↑ AD	↑ rGDP	↓ UR	↑ PL
↓ AD	↓ rGDP	↑ UR	↓ PL

Where,

AD : Aggregate Demand

GDP : Gross Domestic Profit

UR : Unemployment Rate

PL : Price Level

A change in any of the components of aggregate demand will cause AD to shift, creating a new short-run macroeconomic equilibrium. In other words, in our AD=C+I+G+NX equation, anything that increases C, I, G, or NX will shift AD to the right. Anything that decreases C, I, G, or NX will shift AD to the left.

The impact of a shock to SRAS as described in the table below:

Supply shock	impact on rGDP	impact on unemployment	impact on price level
↑SRAS	↑rGDP	↓ UR	↓ PL
↓SRAS	↓rGDP	↑ UR	↑ PL

Where, SARS : Short Run Aggregate Supply Curve. All other factors are the same as like the above table.

Shifts in SRAS represent the best and the worst outcomes for an economy. If SRAS increases, we end up with lower prices, less unemployment, and more output! On the other hand, decreases in SRAS give us more of what we like the least: less stuff, more unemployment, and higher prices.

Positive demand shocks

This economy was initially at long-run equilibrium, so its current output (Y₁ ) was equal to its full employment output ( Y _{f )}. As the result of an increase in one of the components of AD, the entire curve will increase (shift to the right). At the old price level, AD would exceed SRAS. This excess demand puts upward pressure on the price level until the economy assumes a new short-run equilibrium at a higher price level (PL₂ ) and higher output (Y₂ ). Because output has increased, the unemployment rate has decreased.

This economy was initially at long-run equilibrium, so its current output (Y ₁ ) was equal to its full employment output (Y_f ) the old price level, AD would exceed SRAS. This excess demand puts upward pressure on the price level until the economy assumes a new short-run equilibrium at a higher price level (PL_2PL2​P, L, start subscript, 2, end subscript) and higher output (Y_2Y2​Y, start subscript, 2, end subscript). Because output has increased, the unemployment rate has decreased.

Positive supply shocks

This economy was initially at long-run equilibrium, and its current output (Y₁ ) was equal to its full employment output (Y_f ) .Something has changed in the economy making output cheaper for producers, such as a decrease in the cost of labor. At the old price level, SRAS would exceed AD. This surplus output puts downward pressure on the price level until the economy assumes a new short-run equilibrium at a lower price level (PL₂ ) and higher output (Y₂ ) . Because output has increased, the unemployment rate has decreased.

Shifts in SRAS are caused by things that impact the ability to produce goods and services in the short run. The most common factor that affects SRAS is an economy-wide change in factor prices. Some things that impact an economy’s ability to produce are so profound that they have not just a short-run impact, but a long-run impact, which means both the SRAS and LRAS will shift. For example, if more resources become available (like an entirely new form of energy is discovered), then this would shift the LRAS curve to the right. We will develop this idea more in a future lesson, however. For now, focus on the immediate impact a change in the cost of production has on SRAS alone.

The Negative Demand and Supply shocks affects the economy in the other way round . That is

• The entire AD curve has decreased (shifted to the left). At the old price level, SRAS would exceed AD. Because output has decreased, the unemployment rate has increased.
• At the old price level, AD would exceed SRAS. This puts upward pressure on the price level until the economy assumes a new short-run equilibrium at a higher price level.  Because output has decrease, the unemployment rate has increased.