Question

18. Describe and show aggregate equilibrium in the long run including the graph with all three schedules.

19. Describe and show what happens to aggregate equilibrium when AD changes (both increase and decrease; be sure to give at least one reason for the shift).

Answer 1

18) Aggregate equilibrium in the long run is determined by the intersection of 3 schedules. They are the aggregate demand the short run aggregate supply in the long run aggregate supply. Aggregate supply curve is upward sloping , aggregate demand is downward sloping and the long run aggregate supply is vertical and it is a fixed at full employment level of output. When they intersect at a common point it determines the long run equilibrium level of output YF and the corresponding price level PF

19) aggregate demand can increase when there is an expansionary fiscal policy or expansionary monetary policy. This includes increase in government spending decrease in taxes and increase in money supply. Aggregate demand curve shifts to the right and in the short run the economy moves out of its long run equilibrium. This implies that there is inflationary gap in the short-run because output is greater than its full employment level. There is demand pull inflation as well.

aggregate demand can decrease when there is a contractionary fiscal policy or monetary policy. This includes decrease in government spending increase in taxes and decrease in money supply. Aggregate demand curve shifts to the left and in the short run the economy moves in from its long run equilibrium. This implies that there is recessionary gap in the short-run because output is less than its full employment level.