Chapter 32, Problem 2FRQ

a)

To determine

The graph of aggregate demand and aggregate supply that shows an economy in long-run macroeconomic equilibrium.

Explanation of Solution

The graph of aggregate demand and aggregate supply that shows an economy in long-run macroeconomic equilibrium would be drawn as follows:

  

When total demand and total supply are equal in the economy, then there is macroeconomic equilibrium. Long-term changes in aggregate demand only have an impact on changes in the equilibrium price level and have no impact on equilibrium production.

Economics Concept Introduction

Introduction: At the point where the aggregate demand curve and the aggregate supply curve connect, macroeconomic equilibrium takes place when the amount of real GDP requested and supplied is equal.

b)

To determine

What happens on the graph in the short run when the central bank increases the money supply to pay off a government deficit.

Explanation of Solution

  

If the aggregate supply curve is horizontal in the short term, an increase in aggregate demand just causes the equilibrium output Y* and Y* to increase to the points Y₂ Y₂, without any change in the price level.

Moreover, a rise in aggregate demand leads to an increase in the equilibrium output value which is increased on the graph from points Y* and Y* to points Y₂ and Y₂ the equilibrium price level. Therefore, when the central bank increases the money supply to pay off a government deficit

then the short-run aggregate supply curve has a positive slope.

Economics Concept Introduction

Introduction: At the point where the aggregate demand curve and the aggregate supply curve connect, macroeconomic equilibrium takes place when the amount of real GDP requested and supplied is equal.

c)

To determine

What happens in the long run on the graph?

Explanation of Solution

In the long run, production and employment are unaffected by changes in aggregate demand over and only price changes have an impact due to the increase in money supply to pay for the deficit. Price is increased from P₂ to P₃ due to the increase in aggregate demand in the long run.

Economics Concept Introduction

Introduction: At the point where the aggregate demand curve and the aggregate supply curve connect, macroeconomic equilibrium takes place when the amount of real GDP requested and supplied is equal.