determine the effect on either the aggregate demand curve (is it a rightward or
ID: 1234666 • Letter: D
Question
determine the effect on either the aggregate demand curve (is it a rightward or a leftward shift?), the aggregate short-term supply curve, and the long-term aggregate supply curve (does the upward sloping portions of the SAS curve shift left or right, or does the vertical portion of the LAS curve shift to the right or to the left?). Also determine the effect on the price level, the real output level and employment/unemployment. Provide an explanation and express this graphically using the AS/AD macro model.The rapid development of internet technologies during the 1990s allowed businesses to produce goods and services cheaper than before and also gave rise to completely new services. We would show this change in the aggregate-demand/aggregate-supply model by moving the aggregate supply curve down (right) with little change in aggregate demand. Improvements in technology increase potential output and reduce costs, moving the short aggregate supply curve down and the long-run aggregate supply curve to the right.
Explanation / Answer
The aggregate production function shows that the quantity of real GDP (Y ) supplied depends on the quantity of labor (L ), the quantity of capital (K ), and the state of technology. ? When the wage rate makes the quantity of labor supplied equal the quantity of labor demanded, there is full employment. At full employment, the unemployment rate is the natural rate of unemployment, and the amount of GDP produced is potential GDP. Aggregate supply is the relationship between the quantity of real GDP supplied and the price level. Aggregate supply depends on the time frame. The macroeconomic long run is the period of time necessary for all changes to have occurred so that real GDP equals potential GDP. ? The long-run aggregate supply curve, LAS, is the relationship between the price level and real GDP when real GDP equals potential GDP. The LAS curve is vertical, as illustrated in Figure 7.1. ? Along the LAS curve, both the prices of goods and services and the prices of productive resources change. In contrast, the macroeconomic short run is a period during which some money prices are sticky and real GDP might be below, above, or at potential GDP and the unemployment rate might be above, below, or at the natural rate of unemployment. ? Aggregate Demand The quantity of real GDP demanded equals the sum of consumption expenditure (C ), investment (I ), government purchases (G ), and exports (X ) minus imports (M ). Aggregate demand shows the relationship between the quantity of real GDP demanded and the price level. As illustrated in Figure 7.2 the aggregate demand curve, AD, slopes downward. It does so for two reasons: ? Wealth effect — A higher price level decreases the amount of real wealth (that is, the purchasing power of wealth), which decreases the quantity of real GDP demanded. ? Substitution effects — An increase in the price level raises the interest rate, which reduces the quantity of real GDP demanded. In addition, an increase in the U.S. price level raises the price of U.S. goods relative to foreign goods. When aggregate demand increases, the AD curve shifts rightward. Three key factors shift the AD curve: ? Expectations — higher expected future incomes, higher expected inflation, or higher expected profits increase current aggregate demand. ? Fiscal policy and monetary policy — Fiscal policy is government attempts to influence the economy by changing taxes, transfer payments, and government purchases. An increase in government purchases increases aggregate demand. Reduced taxes and increased transfer payments raise disposable income (aggregate income minus taxes plus transfer payments) and thereby increase consumption expenditures and hence aggregate demand. Monetary policy is changes in interest rates and the quantity of money. Increasing the quantity of money or lowering interest rates increases aggregate demand. Economic growth takes place when potential GDP increases. Inflation occurs when aggregate demand increases more than long-run aggregate supply. Business cycles result when aggregate demand and short-run aggregate supply do not grow at the same rate.
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