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Chapter 18: Q6. (page 389)

Between 1990 and 2009, the U.S. price level rose by about 64 percent while real output increased by about 62 percent. Use the aggregate demand–aggregate supply model to illustrate these outcomes graphically.

Short Answer

Expert verified

The following figure illustrates a simultaneous rise in both price level and GDP level in the US economy.

Step by step solution

01

The short-run and long-run impact of rise in oil prices on the economy 

The AD-AS model establishes a relation between the price level and GDP level. Here, the US price level increases by 64 percent while real output increases by 62 percent. The increase in both price level and GDP level occurs due to the rightward shift of the aggregate demand curve.

The following figure illustrates the impact of the rightward shift in the aggregate demand curve on the US economy.

In the above figure, Ef is the long-run equilibrium point, Pf and Qf are the initial price and GDP level, respectively. Due to an increase in demand, the AD0 curve shifts rightwards to AD1. As a result price level rises from Pf to P1, and the actual GDP level rises from Qf to Q1. Thus, an inflationary impact is created in the US economy.

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Most popular questions from this chapter

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.

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?

Why might one person work more, earn more, and pay more income tax when his or her tax rate is cut, while another person will work less, earn less, and pay less income tax under the same circumstance?

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.

Use graphical analysis to show how each of the following will affect the economy, first in the short run and then in the long run. Assume that the United States is initially operating at its full-employment level of output, that prices and wages are eventually flexible both upward and downward, and that there is no counteracting fiscal or monetary policy.

a. Because of a war abroad, the oil supply to the United States is disrupted, sending oil prices rocketing upward.

b. Construction spending on new homes rises dramatically, greatly increasing total U.S. investment spending.

c. Economic recession occurs abroad, significantly reducing foreign purchases of U.S. exports
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