1.2.7 Assume that there are two sectors in an economy: goods

(G) and services (S). Both sectors are perfectly competitive, with large numbers of firms and constant returns to scale. As income rises, households spend a larger portion of their income on S and a smaller portion on G. Using supply and demand curves for both sectors and a diagram showing a representative firm in each sector, explain what would happen to output and prices in the short run and the long run in response to an increase in income. (Assume that the increase in income causes demand for G to shift left and demand for S to shift right.) In the long run, what would happen to employment in the goods sector? in the service sector? (Hint:

See Figure 12.2 on p. 289.)