Question 2

The following diagram shows two economies, A and B. Each are in short-run equilibrium at point E, where the aggregate demand (AD) and aggregate supply (AS) curves intersects.

2.1 Explain why in Economy A wages and other factor prices will begin to rise, and why this will increase firm’s unit costs.

2.2 Given your answer in [2.1], show the effect on the AS curve. Explain what happens to real GDP and the price level.

2.3 Explain why in Economy B wages and other factor prices will begin to fall, and why this will decrease firm’s unit costs.

2.4 Given your answer in [2.3], show the effect on the AS curve. Explain what happens to real GDP and the price level.

 

AS AS E AD AD y* Real GDP Real GDP Economy A Economy B Price Level Price Level