Economic fluctuations II The following graph shows the short-run aggregate suppl
ID: 1193695 • Letter: E
Question
Economic fluctuations II The following graph shows the short-run aggregate supply curve (AS), the aggregate demand curve (AD), and the long-run aggregate supply curve (LRAS) for a hypothetical economy. Initially, the expected price level is equal to the actual price level, and the economy is in long-run equilibrium at its natural rate of output, $120 billion. Suppose war in the worlds main oil-producing region sharply reduces the world oil supply, causing oil prices to rise and increasing the costs of producing goods and services in this economy. Use the graph to help you answer the Questions about the short-run and long-run effects of the increase in production costs that follow. Now suppose that the government decides not to take any action in response to the short-run economic impact of the higher oil prices. In the long-run, when the government does nothing, the output in the economy will be $ billion and the price level will be .Explanation / Answer
a. There is a two way relationship between price level and output. Changes in price level causes changes in REAL GDP, shown by AD. & changes in REAL GDP causes changes in price level shown by AS.
In short run te increase in production cost, where the growth is lower and price is higher gives rises to a specific type of INFLATION known as STAGFLATION.This situation is caused due toa leftward shift of AS. If the AD did not increase significantly but the price level did, then the inflation was caused by supply side forces known as COST-PULL INFLATION. Leftward shift of AS curvewill cause big economic troubles- higher price level, lower output and higher rate of unemployment.
The long-run aggregate supply curve reflects the lack of a cause-and-effect relation between real production and the price level. As the price level rises, real production remains constant at the full-employment level. As the price level falls, real production remains constant at the full-employment level. Due to flexible prices, the same level of real production is generated at every price level.
b. The short run economic out come resulting from the increase in production cost is known as STAGFLATION.
c. Stagflation is considered devastating because prices are rising at the same time as the unemployment rate, making conditions even worse on people without a job or those who live on an already tight budget. In addition, once stagflation starts, it is extremely difficult to stop. If government doest take any steps to curb it, It will cause a higher price level with lower output which in turn will give rise to a higher rate of unemployment through out the country.
d.In the long run if government does nothhing the output in the economy will be $120 Billion and the price level will be 120.
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