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Chapter 14: Problem 9

What is the difference in the long run between a one-shot increase in aggregate demand and a one-shot decrease in short-run aggregate supply?

Short Answer

Expert verified
In the long run, a one-shot increase in aggregate demand increases the price level but retains the same level of real output after self-adjustment. Whereas a one-shot decrease in short-run aggregate supply leads to an increased price level and a decreased real output even in the long run.

Step by step solution

01

Analyze the impact of a one-shot increase in aggregate demand

When there's a one-shot, unexpected increase in aggregate demand, it shifts the AD curve to the right on an AD/SRAS/lRAS graph. During this shift, along the SRAS curve, the result is a higher price level and higher real output in the short run. Assuming that there's no change in aggregate supply, in the long run, the economy will self-adjust. SRAS curve will shift left to intersect with the long-run aggregate supply (LRAS) and the new AD curve, restoring the initial level of real output but with a higher price level.
02

Analyze the impact of a one-shot decrease in short-run aggregate supply

An unexpected one-time decrease in SRAS shifts the SRAS curve to the left. It leads to a decrease in real output and an increase in the price level. Even in the long run, as there's no self-adjusting mechanism to restore real output, it stays decreased, and the price level remains high, assuming constant AD.
03

Compare the impacts

The long-run difference between a one-shot increase in aggregate demand and a one-shot decrease in short-run aggregate supply is that, assuming AD and SRAS are the parameters changing, real output levels eventually restore to original with AD, while it decreases with a reduction in SRAS.

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Most popular questions from this chapter

Suppose the objective of the Fed is to increase Real GDP. To this end, it increases the money supply. Can anything offset the increase in the money supply so that Real GDP does not rise? Explain your answer.

What does inflation look like in a country that imposes and maintains price ceilings on goods and services?

Suppose the money supply rises. Is the interest rate guaranteed to decline initially? Why or why not?

Suppose the money supply rises on Tuesday and by Thursday the interest rate has risen also. Is the rise in the interest rate more likely the result of the income effect or of the expectations effect? Explain your answer.

In recent years, economists have argued about the true value of the real interest rate at any one time and over time. Given that Nominal interest rate \(=\) Real interest rate \(+\) Expected inflation rate, it follows that Real interest rate \(=\) Nominal interest rate \(-\) Expected inflation rate. Why do you think that there is so much disagreement over the true value of the real interest rate?
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