Suppose the full-employment level of real output (Q) for a...

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: a. What will be 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 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 will be 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. Show the circumstances described in parts $a$ and $b$ on graph paper, and derive the long-run aggregate supply curve.

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:
a. What will be 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 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 will be 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. Show the circumstances described in parts $a$ and $b$ on graph paper, and derive the long-run aggregate supply curve.

Key Concepts

Short-run Aggregate Supply (SRAS)

SRAS is the relationship between the price level and the quantity of output that firms are willing to supply in the short run, given that some costs, like wages and input prices, are sticky. This stickiness means that when the price level changes unexpectedly, firms temporarily produce more or less than the full-employment level of output.

Long-run Aggregate Supply (LRAS)

LRAS represents the economy’s potential output when all resources are fully employed; it is vertical because in the long run, output is determined by real factors such as technology, resources, and institutions, not by the price level. Price level changes cause temporary deviations in the short run but eventually the economy returns to its full-employment output in the long run.

Aggregate Demand (AD)

Aggregate Demand is the total demand for goods and services in the economy at various price levels. Changes in AD, such as those stemming from consumer spending, investment, or government policies, can lead to shifts that result in temporary mismatches between aggregate demand and the economy’s potential output.

Full-employment Output

This concept refers to the level of production attained when all resources in the economy are utilized efficiently, often equated with potential or natural level of output. It serves as a benchmark in long-run macroeconomic analysis, where the economy ultimately gravitates back to this level after any short-run disturbances.

Adjustment Mechanism

The adjustment mechanism explains how the economy responds to short-run deviations from full-employment output through changes in wages, prices, and expectations. When the price level changes unexpectedly, initial output deviations occur in the short run, but as input prices adjust—particularly wages—the SRAS shifts until the economy converges back to its long-run, full-employment output.

Transcript

00:01 In this question, we're given a table of short -run aggregate supply schedules, and we want to figure out what the changes in the level of output will be in the short -run in the long run due to price -level changes from shifts in the aggregate demand.

00:15 All right, so first we're looking at the short -run.

00:19 So in the first scenario, we see that price level is rising from 100 to 125 because of an increase in aggregate demand.

00:27 So we can model that on our curve down here.

00:30 So here i have long run aggregate supply, short run aggregate supply, and aggregate demand.

00:35 So if we have an increase in aggregate demand, we're going to shift our curve out to the right.

00:43 And that is going to cause quantity to increase and price level to increase.

00:47 So if we look on our chart, we'll see that if we're looking at this column all the way to the left, right, because we started at a price of 100 and a quantity of 250.

00:57 So if we increase our price level to 250, or sorry, to 125, then we can see that our new quantity is going to increase by 30.

01:07 So our new quantity is going to be, oops, sorry, it's going to be 280.

01:13 All right.

01:14 So next we have the price level falling, right? so i will show this in the opposite way.

01:21 So now we're having aggregate demand shifting to the left.

01:24 So that's going to decrease our price and our quantity.

01:27 So if we look at our chart once again, we'll see that if we go from a price level 100 to 75, we will decrease by 30 again.

01:35 So we're going to be at a quantity of 220.

01:40 All right.

01:41 So quantity will be 220.

01:43 All right.

01:43 So now let's look at the long run effects.

01:45 Right.

01:46 So if we just think about our short run and long run model, right? so in the short run we have our new equilibrium point is going to be where long run or sorry, short run aggregate supply and aggregate demand intersect.

02:00 When we increase aggregate demand, our new point was over here.

02:03 And when we decrease aggregate demand, our new point was over here.

02:07 All right, so let's start with the price level increasing...

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