Economics 1011

Assignment 7

Open Questions

1. During the Great Depression in Canada, the price level fell, real GDP fell and unemployment reached almost 20%. Investment fell and consumption fell. Show the effect of these changes from a vibrant 1929 economy to a battered 1933 economy using the AD/AS model.

2. Using the diagram below answer the following questions.

a.On the diagram, illustrate the short run effects of an increase in aggregate demand caused by an expansion in consumption due to greater consumer confidence.

b.On the diagram, illustrate the long run effects of an increase in aggregate demand caused by expansion of consumption.

3. Use the same diagram as in question 2 to answer the following questions.

a.On the diagram, illustrate the short run effects of a decrease in aggregate demand caused by a decrease in consumption because of the negative shock of COVID19 that decreased overall consumption spending due to consumer pessimism.

b.On the same diagram, illustrate the short run effects of a decrease in aggregate supply caused by a decrease in the supply of goods in services due to lockdowns caused by an increase of COVID19 cases and deaths in the economy.

c.In the short run, can we conclude that the price level decreases in the short run with both of the negative supply and demand shocks? Is the economy in a recessionary situation? Justify your answers.

d.Suppose that these shocks did not affect the potential RGDP of the economy (full employment level). If there is no government intervention, how would the economy go back to long run equilibrium? Justify your answer.

4. Suppose there are two countries A and B that in 1876 had the same RGDP per capita of 1 thousand dollars in a year. Suppose that RGDP of economy A grew from 1876 to 2020 (144 year period) at an average growth rate of 2% per year while country B grew in the same period at an average growth rate of 3% per year.

a. How long did it take economy A and B to double their initial level of RGDP per capita? What year did A and B achieve this? (Hint: use the 72 rule)

b. What is the RGDP per capita of economy A and B by the year 2020? How large is the RGDP per capita of economy B in comparison to economy A?

True/False questions

5. Determine if the following statements are true or false.

__Starting in a long run macroeconomic equilibrium a business cycle occurs due to an aggregate demand shock while nothing else changes in the AD-AS model.

__ Starting in a long run macroeconomic equilibrium a real negative supply shock that affects the AS and the potential output level of the economy creates a business cycle if nothing else changes in the AD-AS model.

__Stagflation occurs if the AS in the short run and potential output suffer a negative shock while nothing else changes in the AD-AS model.

__Covid19 can be understood in the AD-AS model as a stagflation situation.

6. Determine for each statement if it's true or false in regards to long run equilibrium.

__an increase in the inflation rate affects negatively the RGDP in the long run.

__an increase in consumption levels generate a rightward shift of the AS curve in the short run.

__an increase in the investment levels generate a rightward shift of the AD curve.

__starting in a long run macroeconomic equilibrium and keeping constant the AS and potential output curves one can say that a negative AD shock coupled with flexible wages (no sticky wages) generates a recessionary gap.

__a war that destroys human life and capital stock would generate a real shock to an economy which affects negatively the AS curve in the short run as well as the potential output level of the economy.

__a technological innovation would generate a real shock to an economy that would affect positively the AS curve as well as the potential output level of the economy.

7. The US economy is approximately 6 times the size of the Chinese economy in 2020 in terms of RGDP per capita since RGDP pc of the US is $60,000 while that of China is $10,000. Suppose China grows at 4% per year and the US grows at 1% per year. What would be the RGDP per capita of the US and China in the year 2092? Would China have a higher RGDP pc? Justify your answer using the 72 rule.