ECON 1101 - Macroeconomics ; In This Situation - Aggregate Demand (AD)
1.a).Which curve will shift? Is it AS curve or AD curve? In which direction does the shift occur?
b). In the short-run, what will happen to the price level and output (real GDP)?
c). What will happen to the expected price level? What impact does this have on wage bargaining power of workers?
d). In the long-run, which curve will shift due to the change in price expectations created by the stock market boom? In which direct will it shift?
e). How does the new long-run macroeconomic equilibrium differ from the original equilibrium?
2) Studies indicate that net exports and net capital outflows tend to be equal.
a) Why do net exports and net capital outflows tend to be equal? How does an increase in the price level change interest rates?
b) How does this change in interest rates lead to changes in investment and net exports?
3) Assume there is a decrease in the demand for goods and services, which leads to a decrease in the real GDP and eventually the economy into recession.
a) When the economy enters recession due to a decline in demand, what will happen to the price level?
b) Assume there is no government intervention. What will ensure that the economy still eventually gets back to the natural rate of output (real GDP)?
4) A number macroeconomic variables decline during recessions. One of these variables is the GDP.
a) What other variables, besides real GDP, tend to decline during recessions? Given the definition of real GDP and its components, explain the declines in these economic variables which are to be expected.
b) Empirical studies indicate that the long-run trend in real GDP of the USA has an upward trend. How is this possible given business cycles and macroeconomic fluctuations? What factors explain the upward trend in spite of the cycles?
5) Assume there are short-run and long-run Macroeconomic Equilibriums in the economy.
Refer to the AS and AD curves above to answer the following questions.
a). What is the initial point of the long-run macroeconomic equilibrium? What are the equilibrium values? What does the appearance of the long-run aggregate-supply (LRAS) curve indicate? How does it differ from AS?
b). What are the factors that can shift short-run aggregate supply curve from AS1 to AS2? What does Point A represent in the graph? What does point B represent? Is it the short-run or long-run macroeconomic equilibrium? Explain.
c). Assume aggregate demand (AD) is held constant, in the long-run, starting from point B, what will the economy likely experience? Will it reach the long equilibrium?
Answer:
b) During short-run, both the price level and real national income or gross domestic product (GDP) will increase further (Gambetti & Musso, 2017). In figure 1, the price level increases from P1 to P2 while real GDP increases from Y1 to Y2 as well.
c) According to the given situation, expected price level will increase and consequently bargains will be stuck for higher
wages. Workers can earn higher wages for their bargaining power.
d) In long run, the aggregate supply (AS) curve of short-run will shift to the left indicating that supply has decreased. This is shown in figure 1, where the AS curve shifts from AS1 to AS2.
e) In the new long-run macroeconomic equilibrium, price level becomes higher compare to the old one while the real national income remains at same level (Kaufmann & Scheufele, 2017). Hence, the new equilibrium price level in figure 1 is P3 while the equilibrium level of national income remains at Y1.
Figure 1: Aggregate supply and aggregate demand curve
Source: (created by author)
2.a) The production cost of any country is equal to the value of some assets’ reciprocal payments made by purchasers to the producers in other countries. This value of item produced is always equal to the total currency that are traded in the foreign exchange market over a year. In other countries, purchasers trade their assets to transform in equivalent amount of currency to pay for exporting products (Gambetti & Musso, 2017). The compensation related to interest can be demanded more if the expected money value will devalue.
b) Increase in interest rates discourages investment spending of products and consequently demand. Moreover, it influences net exports through decreasing profit margin of industries. Thus, exports are affected adversely and attract foreign investors and consequently currency develops, which further earning revenue from exports of the country increases while cost related to imports decreases (Saint-Paul, 2018). The opposite situation occurs when interest rates decrease.
3.a) When the economy experiences recession due to demand reduction, input prices and output decrease. Moreover, inflation rate decreases during this situation.
b) Decrease in aggregate demand (AD) can lead the price level to fall further. In this context, government intervention is essential to maintain actual price level equal to the expected price level. Otherwise, a person can correct his expectations of price level (Dosi, Pereira, Roventini & Virgillito, 2017). Consequently, wages and prices can be adjusted accordingly and this further can shift the aggregate supply curve to the rightward direction. This phenomenon in turn can shift the aggregate supply curve of the country and this further cause output of the county to increase further at natural rate.
4.a) During recession, all other variables, which decline along with the real GDP of a country, are incomes, employment, sales and investment and home purchases.
GDP can be measured in various ways, for instance, through total production, income or expenditures of a country that can be obtained from final services and goods (Kaufmann & Scheufele, 2017). It can be said that any variable that is used to measure GDP can be changed in the same direction as GDP changes.
b) This situation has become possible when the economy has started to correct itself. During short periods, when real GDP growth rate can be changed negatively, most of the years have experienced real GDP comparatively at a higher rate, which can further compensate negative real GDP growth rate of other years (Saint-Paul, 2018). The factors that explain upward trend are increasing labour force, capital stock and advancement in technological knowledge.
5.
Figure 2: Short-run and long-run macroeconomic equilibrium
a) The long-run macroeconomic equilibrium occurs when aggregate demand (AD) curve intersects with long-run aggregate supply (LRAS) curve at point A in figure 2. Hence, the corresponding equilibrium price level and output level at this point are P1 and Y1, respectively (Dosi, Pereira, Roventini & Virgillito, 2017). This LRAS indicates full level of potential gross domestic product. The chief difference between AS and LRAS is that the second one does not change when price changes while AS can change.
b) In short-run, factors that can shift aggregate supply curves are technology, labour, change in expected price level and natural resources (Saint-Paul, 2018). Point A is representing long-run equilibrium. Point B represents short-run equilibrium.
c) In the long-run, the economy can experience increasing price level and decreasing level of output. No, in long-run, the economy will not experience equilibrium as LRAS cannot reach at point B.
References:
Dosi, G., Pereira, M. C., Roventini, A., & Virgillito, M. E. (2017). When more flexibility yields more fragility: The microfoundations of keynesian aggregate unemployment. Journal of Economic Dynamics and Control, 81, 162-186.
Gambetti, L., & Musso, A. (2017). Loan supply shocks and the business cycle. Journal of Applied Econometrics, 32(4), 764-782.
Kaufmann, D., & Scheufele, R. (2017). Business tendency surveys and macroeconomic fluctuations. International Journal of Forecasting, 33(4), 878-893.
Saint-Paul, G. (2018). The Possibility of Ideological Bias in Structural Macroeconomic Models. American Economic Journal: Macroeconomics, 10(1), 216-41.
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