Consider a AD-AS model of the economy where the expressions for AD and AS curves are the following:

P = 600 - 0.5Y

P = P_-1 + 0.5 (Y - Y^*)

where:

-Y is real income

-Y^* is full-employment income

-P_-1 is the price level of the previous period

The economy is originally in long-run equilibrium - i.e., real income = full employment income in period 0 and P_-1 = 100.

Answer the following:

1. What is the value of Y^* in this economy? What is the initial equilibrium value of P^*?

2. Suppose that in period 1 there is a permanent increase in aggregate demand, and the expression for AD becomes P = 800 - 0.5Y. What are the short-run equilibrium values of Y and P in period 1?

3. Explain what happens to the AS curve in period 2. What are the short-run equilibrium values of Y and P in period 2?

4. Explain what happens to the AS curve in subsequent periods. What will be the new long-run equilibrium values of Y and P?