Econ 353 Homework 5 Due 10/15 Monday Name 1 In T

econ 353 Homework 5due 1015 Mondayname 1 In T

Identify the core questions: Explain long-term output and aggregate supply decisions, interpret shifts in the AD-AS model based on economic shocks, analyze policy impacts, and discuss macroeconomic adjustments. Illustrate understanding with diagrams and references.

Sample Paper For Above instruction

The long-run determination of economic output is a fundamental concept in macroeconomics, emphasizing that in the long run, the level of output is primarily influenced by factors such as the availability of resources and technological progress rather than price levels. The classical view asserts that while prices may fluctuate, the economy's potential output remains unaffected by these short-term variations.

Specifically, the long-run aggregate supply (LRAS) curve is vertical, indicating that in the long term, output depends solely on productive capacity—namely, the factors of production and technology. Consequently, the level of output in the long run is determined by the supply side of the economy, aligning with the perspective that it is independent of the price level (Mankiw, 2020). This reflects the idea that adjustments in prices, wages, and expectations over time restore the economy to its potential output, regardless of fluctuations in aggregate demand.

Turning to the effects of macroeconomic shocks on aggregate supply and demand, suppose an economy is initially operating at a point where aggregate demand (AD) and short-run aggregate supply (SRAS) intersect at equilibrium point E1, with real GDP Y1 and price level P1. An increase in oil prices, which raises production costs, causes the SRAS curve to shift leftward, leading to a new equilibrium characterized by higher prices and lower output, exemplifying stagflation. Conversely, a decline in home prices reduces consumer wealth, decreasing consumption and shifting AD leftward, resulting in a lower equilibrium output and price level.

Policy responses to such shocks vary. To combat a recessionary gap caused by declining aggregate demand, expansionary fiscal policy—such as increasing government spending or cutting taxes—can shift AD rightward, moving the economy toward full employment. For inflationary gaps caused by supply shocks, supply-side policies like reducing taxes or deregulating industries can enhance productivity and shift SRAS rightward.

Fiscal policy tools include government spending and taxation adjustments, while monetary policy encompasses altering interest rates and money supply to influence aggregate demand. For example, reducing government wages or increasing transfer payments can shift aggregate demand, but policy effectiveness depends on the nature of the shock (Blanchard & Johnson, 2017).

Regarding the introduction of a new computer system in Wageland that enhances labor productivity, the economy will transition from one short-run equilibrium to another. An increase in productivity shifts the SRAS curve to the right, leading to a higher output at a lower price level. Graphically, this is represented by a rightward shift of the SRAS, moving from an initial equilibrium point, E1, to a new, lower-price equilibrium.

The 2007 U.S. recession was fundamentally driven by shocks such as rising oil prices and the collapse of the housing market. These shocks affected aggregate demand and supply differently. A surge in oil prices constitutes a supply shock, raising production costs and shifting SRAS leftward, thereby increasing prices and reducing output (Hamilton, 2009). The housing market collapse decreased household wealth and hence consumption, effectively shifting AD leftward, further deepening recessionary pressures. The combined effect was stagflation, characterized by rising prices and falling output.

Diagrammatically, the initial equilibrium E1 shifted to E3 as the economy experienced these shocks. The movement illustrates a decrease in real GDP and an indeterminate effect on the price level due to opposing influences—cost-push inflation from oil prices and demand contraction from the housing decline (Romer, 2019). The key takeaway is the importance of policy intervention in stabilizing the economy; monetary and fiscal measures are necessary to mitigate these shocks' adverse effects, such as lowering interest rates or increasing government expenditure.

Macro models indicate that in a short-run disequilibrium situation, such as a recessionary gap, the economy tends to self-correct over time through wage and price adjustments. For example, if an economy faces a recession, wages and prices may fall, shifting SRAS rightward and restoring full employment. However, this process can be slow and sometimes requires active policy measures to accelerate recovery (Friedman, 1957).

In conclusion, understanding how shocks affect aggregate demand and supply, and the subsequent policy responses, is fundamental to macroeconomic management. Visual tools like the AD-AS model help illustrate these dynamics, emphasizing the importance of flexible policies to stabilize the economy during periods of fluctuation.

References

• Blanchard, O., & Johnson, D. R. (2017). Macroeconomics (7th ed.). Pearson.
• Friedman, M. (1957). The role of monetary policy. American Economic Review, 57(1), 1-17.
• Hamilton, J. D. (2009). Causes and Consequences of the Oil Shock of 2007–08. Brookings Papers on Economic Activity, 2009(1), 215-261.
• Mankiw, N. G. (2020). Principles of Economics (9th ed.). Cengage Learning.
• Romer, D. (2019). Advanced Macroeconomics (5th ed.). McGraw-Hill Education.