   Chapter 15, Problem 1PA

Chapter
Section
Textbook Problem

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.

Sub part (a):

To determine

Long run equilibrium in AD-AS model.

Explanation

The supply depends upon the price level in the economy. When the price level is higher, the suppliers will be receiving higher income and this would incentivize them to increase the supply in the economy and vice versa. The aggregation of the supply curves of all the firms in the economy is known as the aggregate supply curve. In the short run period, the aggregate supply curve represents the relationship between the price level in the economy and the supply by the firms.

The demand comes from all the economic agents such as the households, firms as well as the government. The demand depends on the price level of the economy. The increase and decrease in the price level determines the level of demand in the economy. The aggregation of all the individual demands in the economy is known as the aggregate demand thus, the aggregate demand explains the relationship between the general price level and the level of real GDP demanded in the economy by the economic agents such as the households, firms and the government...

Sub part (b):

To determine

Long run equilibrium in AD-AS model.

Sub part (c):

To determine

Long run equilibrium in AD-AS model.

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