Suppose the potential level of real GDP for a hypothetical economy is $160 and the price level (P)initially is 200.Use the following short-run aggregate supply schedules to answer the questions.

Question

Quizplus · Accepted Answer

The Answer is

(a)What will be the short-run level of real GDP if the price level rises unexpectedly from 200 to 210 because of an increase in aggregate demand? Falls unexpectedly from 200 to 190 because of a decrease in aggregate demand? Explain each situation.
(b)What will be the long-run level of real GDP when the price level rises from 200 to 210? Falls from 200 to 190? Explain each situation.
(a)In the short run,real GDP will rise to $190 when the price level rises from 200 to 210.If the price level were to fall unexpectedly from 200 to 190,then the real GDP would fall to $130 temporarily.The changes in the short-run are only temporary responses to changes in aggregate demand.
(b)In the long-run,wages and resource prices adapt to the changes in the price level.Therefore,if the price level rises to 210,wages and resources prices in the long-run will rise by the same percentage as the price level and the aggregate supply will shift from AS (P = 200)to AS (P = 210).Business profits will fall to their original level and the motivation to expand or contract output will disappear.The long-run real GDP will be $160,its potential level.On the other hand,if the price level falls to 90,wages and resources prices in the long-run will fall by the same percentage as the price level and the aggregate supply will shift from AS (P = 100)to AS (P = 90).Business profits will rise to their original level and real GDP returns to $160,its potential level.

Suppose the Potential Level of Real GDP for a Hypothetical