A country s economy is in a short-run equilibrium with an output level less than the full-employment output level. Assume an upwardsloping aggregate

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1 ADAS Practice

2 A country s economy is in a short-run equilibrium with an output level less than the full-employment output level. Assume an upwardsloping aggregate supply curve. (a) Using a correctly labeled aggregate demand and aggregate supply graph, show the following. (i) Full-employment output, labeled as YF (ii) Equilibrium real output and price level, labeled as YE and E, respectively (b) Assume that the country s government increases domestic military expenditures. On the graph from part (a), show how the increased military expenditures affect the following in the short run. (i) Aggregate demand (ii) Equilibrium real output and price level, labeled as Y2 and 2, respectively (c) Assume that the increased military spending is financed through government borrowing. What will happen to the real interest rate? Explain. (d) Assume that the economy produces only two goods: military goods and civilian goods. Using a correctly labeled production possibilities curve, show the effect of the increase in military expenditures from part (b), labeling the initial point as C and the new point as D.

3 Military Goods Answer LRAS SRAS (c) Increase government spending -> increase D for Loanable funds -> Increase real interest rates 2 E AD AD 2 D Y E Y F GDP R C Y 2 Civilian Goods

4 How does each of the following changes affect the real gross domestic product and price level of an open economy in the short run? Explain each. (a) An increase in the price of crude oil, an important natural resource (b) A technological change that increases the productivity of labor (c) An increase in spending by consumers (d) The depreciation of the country s currency in the foreign exchange market

5 Answer (a) Increase price of oil -> decrease SRAS-> Increase and Decrease GDP (b) Productivity increases -> increase SRAS - > decrease and Increase GDP (c) increase C -> increase AD -> increase and increase GDP (d) depreciation -> exports seem cheaper -> increase X -> increase AD -> increase and GDP

6 Assume that declining stock market prices in the United States cause many US financial investors to sell their stocks and increase their money holdings. A. Due to the decline in wealth caused by the change in stock prices, the general price level in the US falls relative to the in Japan, a trading partner. Use a correctly labeled graph of the foreign exchange market for the US dollar to show the impact of the of the change in relative on each of the following 1. Demand for the dollar 2. Price of the dollar B. How will the change in the price of the dollar you indicated in part a, affect net exports of the US? Explain C. Using a correctly labeled graph of the ADAS graph, show how the change in net exports in part B will affect each of the following in the short run 1. Aggregate Demand 2. Output and Price Level D. Given your answer in part C, what will happen to unemployment in the short run? explain

7 Answer LRAS /$ SRAS S $ P D $ D $2 2 AD Q Q Q $ Appreciation, goods seem more expensive, decrease exports, decrease net exports Y 2 Y F AD 2 GDP R Output goes down, unemployment goes up

8 Assume the economy of Andersonland is in a long-run equilibrium with full employment. In the short run, nominal wages are fixed. (a) Draw a correctly labeled graph of SRAS, LRAS, and AD. Show each of the following. (i) Equilibrium output, labeled Y1 and (ii) Equilibrium price level, labeled 1 (b) Assume that there is an increase in exports from Andersonland. On your graph, show the effect of higher exports on the equilibrium in the short run, labeling the new equilibrium output and price level Y2 and 2, (c) Based on your answer in part (b), what is the impact of higher exports on real wages in the short run? Explain. (d) As a result of the increase in exports, export-oriented industries in Andersonland increase expenditures on new container ships and equipment. (i) What component of aggregate demand will change? (ii) What is the impact on the long-run aggregate supply? Explain

9 Answer LRAS SRAS If business buy more container ships, then I increase. 2 AD 2 Long run will shift to the right because capital stock has increased AD Y 1 Y 2 GDP R If nominal wages are fixed and there is inflation, then real wages will decrease

10 Assume the US economy is currently operating at an equilibrium below full employment. (a) Draw a correctly labeled graph of AD and AS, and show each of the following Long Run Aggregate Supply Current equilibrium output and price level (b) Now assume a significant increase in the world price of oil, a major production input for the US. Show on your graph how this effects SRAS and Real Output and Price level (c) Given your answer in part (b), explain what will happen to unemployment in the US. (d) Assume that the United States trades with Japan. Draw a correctly labeled graph of the FOREX market for the US dollar. Based on your indicated change in real output in part (b), show and explain how the supply of the US dollar will be affected in the FOREX (e) Given your answer in part (d), indicate what will happen to the value of the US dollar relative to the Japanese yen.

11 /$ S $2 LRAS SRAS 2 P 2 S $ SRAS P 2 D $ 1 Y 2 Y 1 Y F AD GDP R Unemployment in the US will increase because output has decreased Q 2 Q $ Q If output decreases, then income decreases. If income goes down then people in US won t be able to purchase as many foreign made goods. Decreasing the Supply for the dollar Appreciate

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