What happens to prices and output when the long run and the short run aggregate supply curves shift left?

1. List and explain the three reasons the aggregate-demand curve is downward sloping.

The aggregate-demand curve is downward sloping because: (1) a decrease in the price level makes consumers feel wealthier, which in turn encourages them to spend more, so there is a larger quantity of goods and services demanded; (2) a lower price level reduces the interest rate, encouraging greater spending on investment, so there is a larger quantity of goods and services demanded; (3) a fall in the U.S. price level causes U.S. interest rates to fall, so the real exchange rate depreciates, stimulating U.S. net exports, so there is a larger quantity of goods and services demanded.

2. Explain why the long-run aggregate-supply curve is vertical

The long-run aggregate supply curve is vertical because in the long run, an economy's supply of goods and services depends on its supplies of capital, labor, and natural resources and on the available production technology used to turn these resources into goods and services. The price level does not affect these long-run determinants of real GDP.

3. What might shift the aggregate-demand curve to the left? Use the model of aggregate demand and aggregate supply to trace through the short-run and long-run effects of such a shift on output and the price level

The aggregate-demand curve might shift to the left when something (other than a rise in the price level) causes a reduction in consumption spending (such as a desire for increased saving), a reduction in investment spending (such as increased taxes on the returns to investment), decreased government spending (such as a cutback in defense spending), or reduced net exports (such as when foreign economies go into recession).

The figure below traces through the steps of such a shift in aggregate demand. The economy begins in equilibrium, with short-run aggregate supply, AS1, intersecting aggregate demand, AD1, at point A. When the aggregate-demand curve shifts to the left to AD2, the economy moves from point A to point B, reducing the price level and the quantity of output. Over time, people adjust their perceptions, wages, and prices, shifting the short-run aggregate-supply curve down to AS2, and moving the economy from point B to point C, which is back on the long-run aggregate-supply curve and has a lower price level.

4. What might shift the aggregate-supply curve to the left? Use the model of aggregate demand and aggregate supply to trace through the short-run and long-run effects of such a shift on output and the price level

The aggregate-supply curve might shift to the left because of a decline in the economy's capital stock, labor supply, or productivity, or an increase in the natural rate of unemployment, all of which shift both the long-run and short-run aggregate-supply curves to the left. An increase in the expected price level shifts just the short-run aggregate-supply curve (not the long-run aggregate-supply curve) to the left.

The figure below traces through the effects of a shift in short-run aggregate supply. The economy starts in equilibrium at point A. The aggregate-supply curve shifts to the left from AS1 to AS2. The new equilibrium is at point B, the intersection of the aggregate-demand curve and AS2. As time goes on, perceptions and expectations adjust and the economy returns to long-run equilibrium at point A, because the short-run aggregate-supply curve shifts back to its original position.

 5.       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 price level in the short run. What happens to the unemployment rate?

A stock market crash leads to a leftward shift of aggregate demand. The equilibrium level of output and the price level will fall. Because the quantity of output is less than the natural rate of output, the unemployment rate will rise above the natural rate of unemployment.

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 there is no change in policy). What role does the expected price level play in this adjustment? Be sure to illustrate your analysis in a graph.

If nominal wages are unchanged as the price level falls, firms will be forced to cut back on employment and production. Over time as expectations adjust, the short-run aggregate-supply curve will shift to the right, moving the economy back to the natural rate of output.

6.       Explain whether each of the following events will increase, decrease, or have no effect on short-run aggregate supply.  Illustrate your answer with a AD/AS graph and show the SR equilibrium.

a.       The United States experiences a wave of immigration

When the United States experiences a wave of immigration, the labor force increases, so long-run aggregate supply shifts to the right.

b.      Congress raises the minimum wage to $10 per hour

When Congress raises the minimum wage to $10 per hour, the natural rate of unemployment rises, so the long-run aggregate-supply curve shifts to the left.

c.       Intel invents a new and more powerful computer chip

When Intel invents a new and more powerful computer chip, productivity increases, so long-run aggregate supply increases because more output can be produced with the same inputs.

d.      A severe hurricane damages factories long the East Coast.

When a severe hurricane damages factories along the East Coast, the capital stock is smaller, so long-run aggregate supply declines.

7.       In 1939, the U.S. economy not yet fully recovered from the Great Depression, President Roosevelt proclaimed that Thanksgiving would fall a week earlier than usual so that the shopping period before Christmas would be longer. Explain what President Roosevelt might have been trying to achieve, using the model of aggregate demand and aggregate supply.

The idea of lengthening the shopping period between Thanksgiving and Christmas was to increase aggregate demand. This could increase output back to its long-run equilibrium level

8.       Explain why the following statements are false.

a.       “The aggregate-demand curve slopes down ward because it is the horizontal sum of the demand curves for individual goods.”

The statement that "the aggregate-demand curve slopes downward because it is the horizontal sum of the demand curves for individual goods" is false. The aggregate-demand curve slopes downward because a fall in the price level raises the overall quantity of goods and services demanded through the wealth effect, the interest-rate effect, and the exchange-rate effect.

b.      “The long-run aggregate-supply curve is vertical because economic forces do not affect long-run aggregate supply.”

The statement that "the long-run aggregate-supply curve is vertical because economic forces do not affect long-run aggregate supply" is false. Economic forces of various kinds (such as population and productivity) do affect long-run aggregate supply. The long-run aggregate-supply curve is vertical because the price level does not affect long-run aggregate supply.

c.       “If firms adjusted their prices every day, then the short-run aggregate-supply curve would be horizontal.”

The statement that "if firms adjusted their prices every day, then the short-run aggregate-supply curve would be horizontal" is false. If firms adjusted prices quickly and if sticky prices were the only possible cause for the upward slope of the short-run aggregate-supply curve, then the short-run aggregate-supply curve would be vertical, not horizontal. The short-run aggregate supply curve would be horizontal only if prices were completely fixed.

d.      “Whenever the economy enters a recession, its long-run aggregate-supply curve shifts to the left.”

The statement that "whenever the economy enters a recession, its long-run aggregate-supply curve shifts to the left" is false. An economy could enter a recession if either the aggregate-demand curve or the short-run aggregate-supply curve shifts to the left.

9.       Suppose that the economy is currently in a recession. If policymakers that no action, how will the economy change over time? Explain in words and using an aggregate-demand/aggregate-supply diagram.

The figure below depicts an economy in a recession. The short-run aggregate-supply curve is AS1 and the economy is at equilibrium at point A, which is to the left of the long-run aggregate-supply curve. If policymakers take no action, the economy will return to the long-run aggregate-supply curve over time as the short-run aggregate-supply curve shifts to the right to AS2. The economy's new equilibrium is at point B.

10.   For each of the following events, explain the short-run and long-run effects on output and the price level, assuming policymakers take no actions.  Illustrate your answers in both the 3-graph framework and the AD/AS framework

a.       The stock market declines sharply, reducing consumers’ wealth.

When the stock market declines sharply, wealth declines, so the aggregate-demand curve shifts to the left, as shown in Figure. In the short run, the economy moves from point A to point B, as output declines and the price level declines. In the long run, the short-run aggregate-supply curve shifts to the right to restore equilibrium at point C, with unchanged output and a lower price level compared to point A.

b.      The federal government increases spending on national defense.

When the federal government increases spending on national defense, the rise in government purchases shifts the aggregate-demand curve to the right, as shown in the figure. In the short run, the economy moves from point A to point B, as output and the price level rise. In the long run, the short-run aggregate-supply curve shifts to the left to restore equilibrium at point C, with unchanged output and a higher price level compared to point A.

c.       A technological improvement raises productivity

When a technological improvement raises productivity, the long-run and short-run aggregate-supply curves shift to the right, as shown in the figure. The economy moves from point A to point B, as output rises and the price level declines.

d.      A recession overseas causes foreigners to buy fewer U.S. goods.

When a recession overseas causes foreigners to buy fewer U.S. goods, net exports decline, so the aggregate-demand curve shifts to the left, as shown in the figure. In the short run, the economy moves from point A to point B, as output declines and the price level declines. In the long run, the short-run aggregate-supply curve shifts to the right to restore equilibrium at point C, with unchanged output and a lower price level compared to point A.

What happens to prices and output in the long

What happens to prices and output in the short run?

What is the relationship between short run aggregate supply and long

Which of these will shift the short run aggregate supply curve to the left?