Suppose firms become optimistic about future business...

Suppose firms become optimistic about future business conditions and invest heavily in new capital equipment. a. Draw an aggregate-demand/aggregate-supply diagram to show the short-run effect of this optimism on the economy. Label the new levels of prices and real output. Explain in words why the aggregate quantity of output supplied changes. b. Now use the diagram from part (a) to show the new long-run equilibrium of the economy. (For now, assume there is no change in the long-run aggregate-supply curve.) Explain in words why the aggregate quantity of output demanded changes between the short run and the long run. c. How might the investment boom affect the long-run aggregate-supply curve? Explain.

Transcript

00:01 So here we have a news story about firm optimism.

00:03 The first thing says to draw an aggregate demand, aggregate supply model, so that's exactly what i'll do.

00:08 But even if it didn't ask you to draw it, you still should, right? aggregate demand is a downward sloping function.

00:16 Aggregate supply is an upward sloping function.

00:19 Aggregate supply briefly represents firm pricing.

00:23 Aggregate demand represents c plus i plus g plus nx.

00:28 And we also are going to include long run aggregate supply here, right? long run aggregate supply is vertical at potential output reflecting economic capacity, right? how much the economy is capable of producing when everything is running smoothly, right? so now we have to model the shock.

00:48 And i would say that the firm's optimism is given away by the keyword they invest more, right? firms are going to buy a lot of new stuff.

01:00 They are buying new capital equipment.

01:01 They are increasing investment.

01:04 And so i would model this as a positive shock to aggregate demand, right? firms are investing more.

01:12 They are raising their demand for investment.

01:15 And so in the short run, we have an equilibrium up here that is consistent with rising prices and an economic boom as output is in exchange.

01:26 In excess of potential, right? so we move up the as curve, right? firms get new orders, and facing sticky wages or prices depends on what friction you believe in, cannot adjust p perfectly.

02:04 So normally, right, the reason we don't stay on long run aggregate supply is because when we draw aggregate demand aggregate supply, there is some friction in the background, right? it depends on what your instructor is using.

02:16 We get some sort of sticky wages or sticky prices...

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