Essentials of Economics Study Set 12

Answer:

Effects of an event on price and output in short run and long run:
a.
A sharp fall in the stock market causes shrink in consumers' wealth. In short run, a fall in consumers' wealth will reduce the aggregate demand and causes inward shift in aggregate demand. As a result, price level will fall and, consequently, output level will reduce.
Whereas, in long run a fall in consumers' wealth will reduce the aggregate demand and cause inward shift in aggregate demand. It will lead to fall in price, and consequently, aggregate supply curve will shift rightward to adjust the equilibrium level of output.
b.
The federal government increased expenditure on national defense. Spending on national defense may increase buying weapons and expand the arm force; as a result, employment opportunities in the country will increase and cause the aggregate demand to increase. As aggregate demand increases, price level will increase and cause the aggregate supply to increase. Therefore, in short run, increase in spending on defense will lead to increase in output.
Whereas, in long run, an increase in aggregate demand leads to rise in price level to adjust the disequilibrium between aggregate demand and supply. Hence, level of output will remain unchanged.
c.
A technological improvement increases the productivity; as a result, aggregate supply will increase and cause the price level to fall. This in turn, will raise the aggregate demand. The technological progress raises productivity; hence, output will increase in both short run and long run as well.
d.
A recession in foreign countries reduced the export of U.S. goods and services; as a result, aggregate demand in the U.S. economy reduced and caused the price level to fall. In short run, the fall in price will lead to fall in aggregate supply; hence, output will reduce to keep the aggregate demand and supply in equilibrium.
Whereas, in long run, the fall in aggregate demand will reduce the price level to adjust the disequilibrium in aggregate demand and supply.

Answer:

The aggregate-supply curve shifts to the left because of a decline in the economy's capital stock, labor supply, or productivity, or an increase in the natural rate of unemployment, all of which shift both the long-run and short-run aggregate-supply curves to the left. An increase in the expected price level shifts just the short-run aggregate-supply curve (not the long-run aggregate-supply curve) to the left.
In a short run, the economy starts in equilibrium at point A. The aggregate-supply curve shifts to the left from AS 1 to AS 2. The new equilibrium is at point B, the intersection of the aggregate-demand curve and AS 2. As time goes on, perceptions and expectations adjust and the economy returns to long-run equilibrium at point A, because the short-run aggregate-supply curve shifts back to its original position.

Answer:

a. According to the sticky-wage theory , the economy is in a recession because the unexpected decline in the price level resulted in the raise in real wages; therefore, labor demand is too low. The economy of aggregate supply gets quickly affected by the level of demand. Over time, as nominal wages are adjusted so that real wages decline, the economy returns to full employment.
According to the sticky-price theory , the economy is in a recession because not all prices adjust quickly. Over time, firms are able to adjust their prices more fully, and the economy returns to the long-run aggregate-supply curve.
According to the misperceptions theory , the economy is in a recession when the price level is below what was expected. Over time, as people observe the lower price level, their expectations adjust, and the economy returns to the long-run aggregate-supply curve.
b. The speed of the recovery in each theory depends on how quickly price expectations, wages, and prices adjust. Here, X axes represents Quantity of output and Y axes represents Price level and demand and supply curves will be shown below diagram.