Question 8

8. Economic fluctuations I The following graph shows a hypothetical economy in long-run equilibrium at an expected price level of 120 and a natural output level of $600 billion. Suppose firms become pessimistic about future business conditions and cut back on investment spending. Using the graph, shift the short-run aggregate supply (AS) curve or the aggregate demand (AD) curve to show the short-run impact of the business PESSIMISMm. @ 240 O 200 AS AD . 160 4 AS 5 1 120 w o r o &0 D 40 0 } } t } 0 200 400 600 800 1000 1200 OUTPUT (Billions of dollars) In the short run, the decrease in investment spending associated with business pessimism causes the price level to w the price level people expected and the quantity of output to W the natural level of output. The business pessimism will cause the unemployment rate to W the natural rate of unemployment in the short run. Again, the following graph shows a hypothetical economy experiencing long-run equilibrium at the expected price level of 120 and natural output level of $600 billion, prior to the decrease in investment spending associated with business pessimism. Along the transition from the short run to the long run, price-level expectations will w and the w curve will shift to the W Using the graph, illustrate the long-run impact of the business pessimism by shifting both the aggregate demand (AD) curve and the short-run aggregate supply (AS) curve in the appropriate directions. @ 240 7 O 200 AD O 160 _ AS m = w 1z w o o o a0 40 0 + + + b o 200 400 600 200 1000 1200 QUTPUT (Billions of dollars) In the long run, due to the business pessimism, the price level w , the quantity of output w the natural level of output, and the unemployment rate = the natural rate. e e Save & Continue 9. Economic fluctuations II The following graph shows the aggregate demand curve (AD), the short-run aggregate supply curve (AS), and the long-run aggregate supply curve (LRAS) for a hypothetical economy. Initially, the expected price level equals the actual price level, and the economy experiences long-run equilibrium at a natural level of output of $120 billion. Suppose war in the world's main oil-producing region sharply reduces the world oil supply, causing oil prices to rise and increasing the costs of producing goods and services. Use the graph to help you answer the guestions about the short-run and long-run effects of the increase in production costs that follow. (Note: You will not be graded on any adjustments made to the graph.) Hint: For simplicity, ignore any possible impact of the higher oil prices on the natural level of output. @ 140 LRAS o 135 AS AD 130 + O r 125 AS m i O 420 .-+ A = n E 1 a 115 I LRAS I 10 : AD I 105 I I I 100 t + + t t t i 100 105 110 115 120 125 130 135 140 QUTPUT (Billions of dollars) The short-run economic outcome resulting from the increase in production costs is known as v . Suppose now that the government decides not to take any action in response to the short-run impact of the higher oil prices. In the long run, given that the government does nothing, the output level in the economy will equal S billion and the price level will equal = e