8. Economic fluctuations I The following graph shows the economy in long-run equilibrium at the expected price level of 120 and the natural level of output of $600 billion. Suppose firms become pessimistic about future business conditions and cut back on investment spending. Shift the short-run aggregate supply (AS) curve or the aggregate demand (AD) curve to show the short-run impact of the business pessimism. (?) 240 O 200 AS AD 160 AS 120 PRICE LEVEL 80 AD 40 200 400 600 800 1000 1200 OUTPUT (Billions of dollars) In the short run, the decrease in investment spending associated with business pessimism causes the price level to the price level people expected and the quantity of output to the natural level of output. The business pessimism will cause the unemployment rate to the natural rate of unemployment in the short run. Again, the following graph shows the economy in long-run equilibrium at the expected price level of 120 and the natural level of output of $600 billion, before the decrease in investment spending associated with business pessimism. During the transition from the short run to the long run, price-level expectations will and the curve will shift to the__ Now show the long-run impact of the business pessimism by shifting both the aggregate demand (AD) curve and the short-run aggregate supply (AS) curve to the appropriate positions.Now show the long-run impact of the business pessimism by shifting bath the aggregate demand (AD) curve and the short-run aggregate supply (AS) curve to the appropriate positions. PRICE LEVEL 0 200 40:1 50:] am OUTPUT (Billions of dollars) 1000 AD 1200 In the long run, as a result of the business pessimism, the price level level of output, and the unemployment rate V , the quantity of output V the natural rate of unemployment. V the natural The following graph shows the short-run aggregate supply curve (AS), the aggregate demand curve (AD), and the long-run aggregate supply curve { IRAS) for a hypothetical economy. Initially, the expected price level is equal to the actual price level, and the economy is in long-run equilibrium at its natural level of output, $110 billion. Suppose a bout of severe weather drives up agricultural costs, increases the costs of transporting goods and services, and increases the costs of producing goods and services in this economy. Use the graph to help you answer the questions about the short-mo and tong-run effecB of the Increase in production cosm that follow. (Note: You wr'l'! not be graded on any adjustments made to the graph.) Hint: For simplicity, ignore any possible impact of the severe weather on the natural level of output. ('2) 130 LRAS 0 125 AS AD 120 _:|_ El 115 AS uJ d 110 + Q E 195 LRAS 100 95 so 90 95 100 105 110 115 120 125 130 OUTPUT {Billions of dollars) The short-run economic outcome resulting from the increase in production costs is known as V . Now suppose that the government decides not to take any ach'on in response to the short-run economic impact of the severe weather. In the long run, when the government does nothing, the output in the economy will be billion and the price level will be S. 7. Determinants of aggregate supply The following graph shows a decrease in short-run aggregate supply (AS) in a hypothetical economy where the currency is the dollar. Specifically, the short-run aggregate supply curve shifts to the left from AS, to AS2, causing the quantity of output supplied at a price level of 100 to fall from $200 billion to $150 billion. ? 200 AS, 175 AS1 150 125 100 PRICE LEVEL 75 50 25 50 100 150 250 300 350 400 QUANTITY OF OUTPUT The following table lists several determinants of short-run aggregate supply. Fill in the table by indicating the changes in the determinants necessary to decrease short-run aggregate supply. Change Needed to Decrease AS Inflation expectations Tax rates Burdensome regulations