Suppose the economy is in a long-run equilibrium. a. Draw a...

Suppose the economy is in a long-run equilibrium. a. Draw a diagram to illustrate the state of the economy. Be sure to show aggregate demand, short-run aggregate supply, and long-run aggregate supply. b. Now suppose that a stock market crash causes aggregate demand to fall. Use your diagram to show what happens to output and the price level in the short run. What happens to the unemployment rate? c. Use the sticky-wage theory of aggregate supply to explain what will happen to output and the price level in the long run (assuming no change in policy). What role does the expected price level play in this adjustment? Be sure to illustrate your analysis in a graph.

Suppose the economy is in a long-run equilibrium.
a. Draw a diagram to illustrate the state of the economy. Be sure to show aggregate demand,
short-run aggregate supply, and long-run aggregate supply.
b. Now suppose that a stock market crash causes aggregate demand to fall. Use your diagram
to show what happens to output and the price level in the short run. What happens to the unemployment rate?
c. Use the sticky-wage theory of aggregate supply to explain what will happen to output and the
price level in the long run (assuming no change in policy). What role does the expected price level
play in this adjustment? Be sure to illustrate your analysis in a graph.

Key Concepts

Long-Run Equilibrium

Long-run equilibrium in macroeconomics occurs when the economy’s output is at its potential level and there is full employment. In this state, aggregate demand equals aggregate supply (both short-run and long-run), implying that the economy is utilizing its resources efficiently and that there is no tendency for the output or price level to change absent external shocks.

Aggregate Demand and Aggregate Supply Model

The Aggregate Demand (AD) and Aggregate Supply (AS) model is a fundamental framework used in macroeconomics to analyze fluctuations in the economy. It illustrates the relationship between the overall price level and the total output produced, combining aggregate demand, short-run aggregate supply, and long-run aggregate supply curves. This model helps in understanding the effects of various economic shocks on output and prices.

Aggregate Demand Shock

An aggregate demand shock refers to any sudden event that significantly shifts the aggregate demand curve. A negative shock, such as a stock market crash, reduces consumer and investor confidence, decreasing overall spending in the economy. This shift results in lower output and a lower price level in the short run, affecting overall economic growth and employment levels.

Short-Run Effects and Unemployment

In the short run, a decrease in aggregate demand causes a reduction in output and price levels as the economy moves to a new temporary equilibrium. Unemployment tends to rise because firms produce less and subsequently require fewer workers. This short-run deviation from full employment is characterized by downward shifts in both production and wage levels until slower adjustments gradually restore equilibrium.

Sticky Wage Theory

Sticky wage theory explains that wages do not adjust immediately to changes in economic conditions due to contract rigidity, negotiation lags, and institutional factors. Because of this wage rigidity, the short-run aggregate supply curve is upward sloping, meaning that temporary shifts in inflation or output occur as wages adjust slowly to new economic conditions. This theory helps explain the dynamics of output and employment following demand shocks.

Expected Price Level

The expected price level plays a crucial role in determining short-run aggregate supply. Firms and workers base their wage and price-setting decisions on the expected level of prices. When the actual price level deviates from the expected price level, it leads to misperceptions about relative prices, affecting production decisions. As expectations adjust over time, the SRAS curve shifts, returning the economy to long-run equilibrium outcomes where output aligns with potential levels.

Transcript

00:01 Okay, question one.

00:03 Suppose the economy is in a long -run equilibrium.

00:08 And a question a, draw a diagram to illustrate the state of the economy.

00:13 Be sure to show aggregating men, short -run aggregate supply, and long -run aggregate supply.

00:20 Okay, so the most basic concept we learned from this chapter is that we can also draw this upward sloping supply curve.

00:32 Which is the short run, short run, aggregate supply, and a downward sloping demand curve, which is the short run, short run aggregate demand.

00:56 And the long run aggregate supply is a vertical curve.

01:02 Long run aggregate supply.

01:07 Supply okay okay and we have to know that the y -axis is the price level while the x -axis is the quantity of output i'll just write q here okay so we just simply finish question eight question b now suppose that a stock market crash causes the aggregate demand to fall so this is very obvious we know that now the aggregate demand which is the downward sloping here downward sloping here is going to fall due to a crash in the stock market.

01:42 So all investors or stockholders are facing a loss of their wealth, well, i'll say loss of their property.

01:51 So they don't have that much money to buy things.

01:54 So now we have this left shift of the aggregate demand curve.

02:04 So the equilibrium used to be here, while now the equilibrium falls to the red dot over here, which is the short -run aggregate demand intersect the short -run aggregate supply.

02:19 So in the short run, the price level is going to decrease and the quantity is going to decrease as well.

02:29 And question c, use the sticky wage theory of aggregate supply to explain what will happen to output and the price level in the way.

02:38 Long run, assume no changing policy.

02:42 So what role does they expect price level play in this adjustment and in this adjustment and be sure to illustrate your analysis in a graph.

02:51 So now we already have a graph.

02:53 We so to answer question c, we have to first take a look at the key point.

03:01 So in this question, the key point we have to know in mind is that there is no change in the long run aggregate supply.

03:09 Say something that will change the long run aggregate supply is like a technological change or something like that...

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