Question

1. Describe and briefly explain whether the following changes cause the short-run aggregate supply to

increase, decrease or neither:

a. The price level increases

b. Input prices decrease

c. Firms and workers expect the price level to fall.

d. The price level decreases

e. New policies increase the cost for businesses of meeting government regulations.

f. The number of workers in the labor force increases.

2. Describe and briefly explain whether the following changes cause the aggregate demand to increase,

decrease or neither:

a. The price level increases

b. Investment decreases

c. Imports increase and exports decrease

d. Consumer optimism improves

e. Government increases infrastructure spending

f. Stock market crashes.

3. Starting in early March of 2020, many factories, restaurants, offices and entertainment venues closed

their doors fearing the spread of Coronavirus. Using aggregate demand-aggregate supply model, predict

which curve this event mostly affects and what’s the impact on the US economy in the short-run?

4. From 2014 to 2018, dollar has been slowly falling against other major currencies.

a. Determine how the falling value of the dollar affects the US price level, real GDP and the

unemployment rate in both short-run and the long-run. You can assume that the economy was in the

long-run equilibrium before this change, and consider only the stated event. Place your answers in the

boxes below (using an up arrow, a down arrow, or a dash if the level is constant).

Short Run Long-Run

P Y u P Y u

b. Draw a diagram that supports your answers in part (a). Clearly label all the curves and equilibria as

well as show the direction of changes using arrows.

Answer 1

(a) neither.

If the price level increases, the quantity of the SRAS will increase but it will not shift.

(b) Increases.

Decreasing input prices will make it cheaper to produce goods, which will cause an increase in SRAS.

(c) Increases.

If firms and workers expect the price level to fall, then they negotiate wage contracts with lower nominal wages. This decreases the cost of production and SRAS shifts to the right.

(d) Neither.

If the price level decreases, the quantity of aggregate supply will decrease, but SRAS itself will not shift.

(e) Decreases.

If a new policy increases firms' cost of meeting government regulations, this causes a leftward shift of long-run aggregate supply (LRAS). Remember that whenever LRAS shifts, SRAS shifts with it. Therefore, SRAS will also shift left.

(f) Increases.

If the number of workers in the labor force increases, then resources, too, increase. This will increase LRAS, which means SRAS will increase correspondingly.