Question

What determines the equilibrium price level and real GDP? In the short run, a shift in aggregate demand establishes a new, but temporary, equilibrium along the short-run aggregate supply curve. TRUE or FALSE? Please Explain your Answer. In the long run, the short-run aggregate supply curves shifts so that changes in aggregate demand determine the price level but not the equilibrium level of output or real GDP. TRUE or FALSE? Please explain your answer. Propose three functions of the Federal Reserve System (“the Fed”).

Answer 1

Equilibrium price level and real GDP is decided by:

1. Intersection of AD and SRAS

2. Short run shift in AD, getting new price and output level

3. Long run shift in SRAS to achieve the LR equilibrium at the price level that is achieved by AD.

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Statement 1:

True

In the short run, when aggregate demand shift, then it creates a new price level and output level at the new equilibrium. It is considered as a short term, because short run AS has not acted and it will respond lately. Hence, for a temporary basis, aggregate demand can change the output and price level, but not in the long run.

Statement 2:

True

When aggregate demand shifts, then it creates changes in the market such as demand pull inflation or reduction in cost of production. Due to this reason, the short run aggregate supply changes and achieves back the long run equilibrium of output. Here, the price level will remain same as that was fixed by shift in aggregate demand. So, the movement of SRAS  is crucial to achieve the long run equilibrium.

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Three functions of the Fed are as follows:

1. To act as bankers of the bank

2. Develop and implement monetary policy to look after the health of the economy

3. Develop regulations so that all banks work in the same direction to develop a sound banking system in the economy.