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.

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.

Key Concepts

Aggregate Demand (AD)

Aggregate demand represents the total spending on an economy’s goods and services at various price levels, made up of consumption, investment, government spending, and net exports. Changes in expectations or sentiment about the future can lead to shifts in aggregate demand, causing a movement of the AD curve. In the short run, an increase in aggregate demand tends to raise both the price level and real output.

Short-Run Aggregate Supply (SRAS)

Short-run aggregate supply reflects the relationship between the price level and the quantity of goods and services that firms are willing to produce in the short run, where some input prices, like wages, do not instantly adjust. A temporary increase in demand can lead to higher production and output, as producers respond to increased demand before full adjustments in costs are reflected.

Long-Run Aggregate Supply (LRAS)

Long-run aggregate supply represents an economy’s potential output when all resources are fully employed and prices are fully flexible. It is determined by the fundamental factors of production such as labor, capital, and technology. In the long run, any shift in aggregate demand only affects the price level, while the economy returns to its potential output level, unless there are changes in the productive capacity.

Adjustment Mechanisms (Short Run to Long Run)

The transition from short-run to long-run equilibrium involves adjustments in prices, wages, and expectations. In the short run, stickiness in some prices may allow real output to deviate from its potential level. Over time, as all prices and wages adjust, the economy naturally reverts to its long-run potential output, ensuring that aggregate supply aligns with aggregate demand at the new price level.

Capital Investment and Productive Capacity

Capital investment increases the stock of capital available to firms, which can boost future productivity and potential output. In the short run, increased investment adds to aggregate demand, but over time, the accumulation of capital shifts the long-run aggregate supply curve to the right, reflecting an expansion in the economy’s productive capacity and potential output.

Transcript

00:01 Suppose firms become very optimistic about future business conditions and invest heavily in new capital equipment.

00:10 Question a is asking us to draw an accurate demand and supply diagram to show the short effect of this optimism on the economy.

00:19 Label new levels of prices in real output and explain why the every quantity of our output supply changes.

00:28 So this is actually very intuitive because we know.

00:32 Now that the firm is going to invest more in capital, say they are going to build new machines or they are going to buy a new computer that run faster.

00:43 So that is why they can produce more output.

00:48 So the aggregate supply curve is positive sloping, and aggregate demand is downward sloping.

00:56 So we know that since every firm is going to produce more output, the supply supply.

01:02 Moves to the right hand side.

01:04 The supply line move to the right hand side because there is like an unanimous increase in the amount.

01:15 So this is called aggregate supply prime.

01:20 All right.

01:21 So question b is saying that now use this same diagram and show the long run equilibrium and explain why the aggregate quantity of output demanded also changes.

01:34 So first of all, we know that the equilibrium is the black dot over here.

01:41 So people, so the economy is in need of this amount of output, say q, big capital q, and the price level is p.

01:56 And after the firm decided to invest in capital, they can produce more.

02:02 So the new equilibrium is larger than the old quantity while the price level goes down.

02:12 Because if the demand, why it doesn't change, they produce more goods...

Please give Ace some feedback