The following graph shows an economy that is currently producing at point A (gre
ID: 1217241 • Letter: T
Question
The following graph shows an economy that is currently producing at point A (grey star symbol), which corresponds to the intersection of the AD_1 and SRAS_1 curves. According to the graph, the potential output of this economy is $9t/$11t/$15t/$13t/$10t Since real GDP is currently $15 trillion (as shown by point A), this level of potential output means there is currently anexpansinory gap a contractionary gap of $4t/$5t/$3t/$2t/$1t Along SRAS_1, wages would have been negotiated based on an expected price level of 140 145 135 Since the actual price level at point A is 140, this means that real wages are same/lower/higher had been negotiated, which will increase/decrease unemployment. If the Fed does not intervene, these labor market conditions would cause nominal wages to increase/decrease shifting the LRAS SRAS AD curve to the Left/Right. Eventually, the economy would reach a new long-run equilibrium. On the previous graph, use the tan point (dash symbol) to indicate the long-run equilibrium output and price level if the Fed does not intervene. (Assume there are no feedback effects on the curve that does not shift.) Now suppose the Fed chooses to intervene in an effort to move the economy more quickly back to its potential output. To do so, the Fed will increase/decrease the money supply, which will increase/decrease the interest rate, thereby giving firms an incentive to decrease/increase investment, shifting the LRAS/SRAS/AD curve to the Left/Right On me previous graph, place the black point (plus symbol) at the new long-run equilibrium output and price level if the Fed intervenes in this way and successfully brings the economy back to long-run equilibrium. (Again, assume there are no feedback effects on the curve that does not shift.) Compare your answers from the previous few questions. If the Fed does not intervene, the economy will likely have relatively high unemployment inflation. On the other hand, if the Fed does intervene, it risks causing relatively high unemployment inflation, if it changes the money supply too much.Explanation / Answer
1. 13 trillion.
This is so because the potential level is determined by LRAS curve, which is at $13 trillion output.
2. Inflationary gap.
This occurs when the real GDP is above the potential level where the supply cannot exceed the potential level and only prices rise.
3. $2 trillion.
An inflationary gap is a difference between the actual GDP and the potential level, 15 - 13 = $2 trillion.
4. Due to higher prices, the workers would want to bid their wages up so that their wages could match the price level. By this act, the SRAS curve would shift back and the equilibrium would be restored where the price level is $160 and real GDP is $13 trillion.
5. Decreases.
The economy is already experiencing inflationary gap, decreasing the money supply is the way out to get out of this situation.
6. Increase.
Interest rates play a wedge between the money demand and supply, reducing supply would increase the interest rates.
7. Decrease.
Investment and interest rates are inversely related to each other. The interest rate is the cost of borrowing funds.
8. AD to left.
Investment is a component of AD, reducing investment implies reducing AD and curve shifting to the right.
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