1. Show in the aggregate demand - aggregate supply framework (AD/AS) an economy in long-run equilibrium....

1. Show in the aggregate demand - aggregate supply framework (AD/AS) an economy in long-run equilibrium. 2. Again in the AD/AS framework, show an economy with an inflationary gap and then show the effects of additional stimulus, say a tax cut, on this economy in the short-run. 3. Suppose that after the stimulus a trade war involving intermediate goods breaks out, reducing aggregate supply. Show the long and short-run effects of this trade war being very clear about price level, output and if you believe there will be a change in long-run aggregate supply. 4. Support your decision to change or not change the long-run aggregate supply. Make your argument based on the price of intermediate goods, e.g., steel, increasing and the effect this has on industries that use the intermediate good.

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Question 1

AD-AS framework in long Run Equilibrium

Long run Aggregate demand is the combined final demand of goods and services that are demanded at a particular price in an economy in long run. And Long run Aggregate supply is the combined final supply of goods and services that are supplied at a given price in an economy in long run. Long run supply curve doesn’t shift independently in the long run. It is assumed that the economy is at full employment. The output stays constant at full employment.. It is determined by the interaction of long run aggregate demand and long run aggregate supply curve.

In long run, wages and prices are held to be flexible. Employment even if changes, comes back to its potential level automatically. The equilibrium stands at full employment level of the economy. Prices may move up or down but the production will remain the same. On the other hand, the aggregate demand curve stays the downward sloping curve.

Refer to the following figure, prices are measured at y axis and output is measured at x axis. LRAD is Long run Aggregate demand and LRAS is the Long run Aggregate Supply. LRAS stands at Y* level of output is the point of full employment.

It is determined by the intersection of LRAS and LRAD. Thus, the equilibrium stands at point E

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Rahul Sunny answered 11 months ago

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