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The figure above shows the aggregate demand, long-run aggregate supply, and short-run aggregate supply functions for a country. Wages and prices are rigid in the short run, but adjust to market conditions in the long run. Currently P = 100 and Y = 1000. Analyze the short-run and long-run consequences of the following events on the price level (P) and the real GDP (Y). The questions are independent of each other. The answer to each question should be a short paragraph.a.As in 1990-91, consumer confidence plummets and the aggregate demand function shifts to the left by 800 units (Shift the AD function to the left by 800 units). What will happen to P and Y in the short run (please give me the numbers)? What will happen to P and Y in the long run (please give me the numbers)? Describe the process of self-correcting mechanism from the beginning to the end.b.After the demand curve shifted to the left in part a above, what kind of a demand-management policy would a typical liberal economist propose, an active policy or do nothing? How about a conservative economist? What justifications would they provide for their respective proposed policies?c.How does an expansionary monetary policy work? (Describe the steps through which an increase in money supply affects the real GDP).d.How does fiscal policy work? (Describe the steps through which an increase in G or TR, or a decrease in TX, affects the real GDP).e.What are the advantages and disadvantages of using an expansionary monetary policy in a recessioncompared to using fiscal policy? (Please note: I am not asking you how monetary policy works. You have already answered it in part c above. The question is specifically about the advantages of monetary policy compared fiscal policy in a recession).f.What are the advantages and disadvantages of using an expansionary fiscal policy in a recession (That is,compared to using monetary policy)?
a.)When the AD curve is shifted leftwards by 800 units, it cuts the SRAS curve at (600,80), i.e., the new equilibrium P=80, Y=600. In the long run, the output shifts back to its original position, i.e., the point where new AD curve cuts LRAS, i.e, P=60, Y=1000. Self correcting mechanism: In the short run, the prices decreased from 100 to 80. But due to incomplete wage price flexibility in the short run, this shift is realized and output falls. But in the long run, due to complete wage price flexibility (w/p=constant), the SRAS curve also shifts by the same proportion such that it cuts the AD curve on the LRAS curve. b.)A conservative economist would do nothing. A liberal economist would follow an active policy to bring the economy back to its original position. c.)As money supply increases, the LM curve shifts rightward, as a result AD shifts rightward, leading to increase in output as well as price level. short run- M rises, Y rises, r falls, price rises. (AD shifted rightward.) long run- since price rises, shifts SRAS curve to the right such that it cuts AD curve on LRAS curve leading to rise in price level but output being the same. d.)IS curve, Y=C(Y-T)+I(r)+G+(X-M) An increase in G or TR or a…

crease in TX, shifts IS curve to the right, leading to rise in output as well as interest rate. This is seen as a shift in the AD curve to the right, leading to rise in prices. e.)Expansionary monetary policy is used as it is faster to implement and bring into effect. But when interest rates reach the boundary of an interest rate of zero percent,conventional monetary policy can no longer be used and government must use other measures to stimulate recovery. Keynesians argue that fiscal policy, tax cuts or increased government spending, will work when monetary policy fails. Spending is more effective because of its larger multiplier but tax cuts take effect faster. f.)Implementation of fiscal policy takes time. It has a formal process as it has to go through parliament so it is a time consuming process.



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