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Chapter 18: Q1. (page 389)

Use the nearby figure to answer the following questions. Assume that the economy initially is operating at price level 120 and real output level $870. This output level is the economy’s potential (full-employment) level of output. Next, suppose that the price level rises from 120 to 130. By how much will real output increase in the short run? In the long run? Instead, now assume that the price level drops from 120 to 110. Assuming flexible product and resource prices, by how much will real output fall in the short run? In the long run? What is the long-run level of output at each of the three price levels shown?

Short Answer

Expert verified

As the price level rises from 120 to 130, the output level increases by $20 in the short-run, while it remains unchanged at $870 in the long-run.

As the price level falls from 120 to 110, the output level decreases by $20 in the short-run while it remains unchanged at $870 in the long run.

The long-run level of output at each price level is $870.

Step by step solution

01

The short-run and long-run impact on output level when the price level rises

The price and output levels are positively correlated in the short-run, while they are uncorrelated in the long run. So the short-run aggregate supply (SRAS) curve is upward sloping while the long-run aggregate supply (LRAS) curve is vertical.

Here, the economy operates at the price level 120, and the potential output level is $870, corresponding to AS2. Now there is an increase in the price level from 120 to 130. In the short run, the economy will move upward along AS2. So, according to the given figure, as the price level rises from 120 to 130, the output level would increase from $870 to $890. Thus, the output level rises by $20 when the price rises from 120 to 130 in the short run.

However, in the long run, when the price level rises from 120 to 130, the aggregate supply curve would shift leftwards from AS2 to AS3. It happens due to a rise in nominal wages which decreases the producers’ profit. So, according to the given figure, as the price rises from 120 to 130, the real output level remains unchanged at $870 in the long--run.

02

The short-run and long-run impact on output level when the price level falls

Now there is a decline in the price level from 120 to 110. In the short run, the economy will move downward along AS2. So, according to the given figure, as the price level falls from 120 to 110, the output level would decrease from $870 to $850. Thus, the output level falls by $20 when the price rises from120 to 110 in the short run.

However, in the long run, when the price level decreases from 120 to 130, the aggregate supply curve would shift rightwards from AS2to AS1.It happens due to a fall in nominal wages which increases the producers’ profit. So as the price declines from 120 to 110, the real output level remains unchanged at $870 in the long run.

Hence, the long-run level of output at each price level is $870.

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Most popular questions from this chapter

Suppose that for years East Confetti’s short-run Phillips Curve was such that each 1 percentage point increase in its unemployment rate was associated with a 2 percentage point decline in its inflation rate. Then, during several recent years, the short-run pattern changed such that its inflation rate rose by 3 percentage points for every 1 percentage point drop in its unemployment rate. Graphically, did East Confetti’s Phillips Curve shift upward or did it shift downward? Explain.

Distinguish between the short run and the long run as they relate to macroeconomics. Why is the distinction important?

Suppose the government misjudges the natural rate of unemployment to be much lower than it actually is and, thus, undertakes expansionary fiscal and monetary policies to lower it. Use the concept of the short-run Phillips Curve to explain why these policies might at first succeed. Use the concept of the long-run Phillips Curve to explain these policies’ long-run outcomes.

Suppose that an economy begins in long-run equilibrium before the price level and real GDP both decline simultaneously. If those changes were caused by only one curve shifting, then those changes are best explained as the result of:

a. the AD curve shifting right.

b. the AS curve shifting right.

c. the AD curve shifting left.

d. the AS curve shifting left.

Suppose the full-employment level of real output (Q) for a hypothetical economy is $250 and the price level (P) initially is 100. Use the short-run aggregate supply schedules below to answer the questions that follow:

AS(P100)
AS(P125)
AS(P75)
PQPQPQ
125280125250125310
100250100220100280
752207519075250

What is the level of real output in the short run if the price level unexpectedly rises from 100 to 125 because of an increase in aggregate demand? What happens if the price level unexpectedly falls from 100 to 75 because of a decrease in aggregate demand? Explain each situation, using numbers from the table.

b. What is the level of real output in the long run when the price level rises from 100 to 125? When it falls from 100 to 75? Explain each situation.

c. Illustrate the circumstances described in parts a and b on graph paper, and derive the long-run aggregate supply curve.
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