Unit 8ab204 Macroeconomics: Unit 8 Assignment Long Run Macro

Unit 8ab204 Macroeconomicsunit 8 Assignment Long Run Macroeconomic

Let us assume the economy reaches its long-run macroeconomic equilibrium in 2020. When the economy is in the long run macroeconomic equilibrium, the stock market will also reach its boom. This will in turn lead to increases in stock prices more than expected, and the stock prices will stay high for some period. Answer the following questions based on the scenarios of long macroeconomic equilibrium and consequent stock market boom.

1. Which curve will shift? Is it AS curve or AD curve? In which direction does the shift occur?

2. In the short-run, what will happen to the price level and output (real GDP)?

3. What will happen to the expected price level? What impact does this have on wage bargaining power of workers?

4. In the long-run, which curve will shift due to the change in price expectations created by the stock market boom? In which direction will it shift?

5. How does the new long-run macroeconomic equilibrium differ from the original equilibrium?

6. Studies indicate that net exports and net capital outflows tend to be equal.

• a) Why do net exports and net capital outflows tend to be equal? How does an increase in the price level change interest rates?
• b) How does this change in interest rates lead to changes in investment and net exports?

7. Assume there is a decrease in the demand for goods and services, which leads to a decrease in the real GDP and eventually the economy into recession.

• a) When the economy enters recession due to a decline in demand, what will happen to the price level?
• b) Assume there is no government intervention. What will ensure that the economy still eventually gets back to the natural rate of output (real GDP)?

8. A number of macroeconomic variables decline during recessions. One of these variables is the GDP.

• a) What other variables, besides real GDP, tend to decline during recessions? Given the definition of real GDP and its components, explain the declines in these economic variables which are to be expected.
• b) Empirical studies indicate that the long-run trend in real GDP of the USA has an upward trend. How is this possible given business cycles and macroeconomic fluctuations? What factors explain the upward trend in spite of the cycles?

9. Assume there are short-run and long-run Macroeconomic Equilibriums in the economy. Refer to the AS and AD curves above to answer the following questions.

• a) What is the initial point of the long-run macroeconomic equilibrium? What are the equilibrium values? What does the appearance of the long-run aggregate-supply (LRAS) curve indicate? How does it differ from AS?
• b) What are the factors that can shift the short-run aggregate supply curve from AS1 to AS2? What does Point A represent in the graph? What does point B represent? Is it the short-run or long-run macroeconomic equilibrium? Explain.
• c) Assume aggregate demand (AD) is held constant, in the long-run, starting from point B, what will the economy likely experience? Will it reach the long equilibrium?

Paper For Above instruction

The analysis of long-run macroeconomic equilibrium and its repercussions on the stock market, as well as the interplay among aggregate supply and demand, net exports, and economic cycles, constitutes a cornerstone of modern macroeconomics. This paper provides a comprehensive exploration of these concepts, focusing on the shifts in macroeconomic curves, short-run and long-run effects, and the cyclical nature of economic variables.

Long-Run Macroeconomic Equilibrium and the Stock Market Boom

In the context of macroeconomic analysis, the aggregate supply (AS) and aggregate demand (AD) curves are fundamental. When the economy reaches its long-run equilibrium, the AS curve is vertical, reflecting the natural level of output determined by factors such as resource availability, technology, and institutional structures. However, a stock market boom can influence these curves significantly. Typically, a boom in the stock market elevates consumer and investor confidence, leading to an increase in aggregate demand. This causes an outward or rightward shift of the AD curve, indicating higher overall demand in the economy.

Initially, the AD curve shifts rightward, increasing the price level and real GDP in the short run. The rise in demand pushes the economy above its full employment output, leading to upward pressure on prices. Concurrently, expectations of higher prices stimulate workers' wage demands, as they anticipate increased living costs. This expected rise in the price level results in an adjustment in wage bargaining, with workers seeking higher wages, which in turn influences the wage-setting process.

In the long run, the shift in expectations caused by the stock market boom results in an upward shift of the aggregate supply curve, specifically the short-run AS (SRAS) curve, reflecting increased production costs. This shift realigns the economy back to its natural level of output, but at a higher price level. Thus, the new long-run equilibrium features a higher price level but unchanged output compared to the initial level. The divergence between the short-run and long-run effects highlights the importance of expectations and adjustment processes in macroeconomic dynamics.

Net Exports, Net Capital Outflows, and Interest Rates

Net exports and net capital outflows tend to be equal primarily due to the balance of payments accounting framework, which links the flow of goods, services, and capital across borders. An increase in domestic price levels makes domestic goods more expensive relative to foreign goods, reducing exports and increasing imports. Concurrently, higher domestic interest rates, often a result of inflationary pressures, attract foreign capital, increasing net capital outflows. Conversely, a rise in interest rates enhances foreign investment in domestic assets, affecting net capital flows.

Changes in interest rates influence investment levels domestically. An increase in interest rates makes borrowing more expensive, dampening investment spending by firms. Simultaneously, higher interest rates abroad may attract foreign capital, impacting net capital outflows. The delicate balance ensures that fluctuations in interest rates and exchange rates collectively influence net exports, weaving a complex interaction between macroeconomic variables.

Recession Due to Decreased Demand and Its Impacts

A decline in demand for goods and services shifts the AD curve leftward, leading to a reduction in real GDP and initiating a recession. During such downturns, price levels may decline or remain sticky downward due to menu costs and wage rigidity. Without government intervention, the economy relies on market mechanisms—such as falling wages and prices—to restore equilibrium at the natural level of output.

The adjustment involves lower wages and prices gradually restoring competitiveness, encouraging increased consumption and investment. Over time, the economy returns to its natural output level, aligning with the full employment condition, although short-term hardship occurs. This self-correcting mechanism is a vital feature of classical economic theory, emphasizing the importance of flexible prices and wages.

Other Variables Declining During Recessions and Long-Run Growth

Besides GDP, variables like employment, industrial production, and consumer spending tend to decline during recessions. These declines occur because lower demand reduces production requirements, leading firms to cut back on labor and investment. As real GDP components—consumption, investment, government spending, and net exports—shrink, so do employment and industrial output, reflecting reduced economic activity.

The long-term upward trend in U.S. real GDP, despite cyclical fluctuations, can be attributed to technological progress, capital accumulation, improved productivity, and institutional improvements. Economic growth results from sustained increases in these fundamental factors, overshadowing short-term downturns caused by business cycles.

Shifts in Aggregate Supply and Demand Curves

The initial long-run equilibrium occurs where the AD and AS curves intersect at the LRAS, indicating full employment output with the price level determined by aggregate demand. The LRAS curve is vertical, representing the economy's potential output unaffected by price changes. Shifts in the short-run aggregate supply curve from AS1 to AS2 can result from factors such as technological advancements, changes in resource prices, or supply shocks.

Point A may represent a short-run equilibrium before adjustments, while Point B could reflect a new equilibrium after shifts. If aggregate demand remains constant, the economy starting from Point B will adjust through shifts in the SRAS or movements in wages and prices until reaching the long-run equilibrium, where the economy operates at its potential output.

Conclusion

Understanding the interactions among aggregate supply, demand, expectations, and external factors provides a comprehensive picture of macroeconomic stability and growth. The mechanisms of curve shifts, cyclical variables, and long-run trends highlight the dynamic nature of economies and the importance of policy, technological progress, and market flexibility in maintaining sustainable growth and stability.

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