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Problem 5.5 Thank you!
230 PARTM The Core of Macroeconomic Theory AS (Long run) AS (Short run Price level, AD By using aggregate supply and demand curves and other useful graphs, illustrate the following: a. Those pushing the Fed to act were right, and prices start to rise more rapidly in 2000. The Fed acts belatedly to slow money growth (contract the money supply), driv ing up interest rates and pushing the economy back to potential GDP b. The worldwide glut gets worse, and the result is a falling price level (deflation) in the United States despite expand ing aggregate demand. 5.4 Using AS and AD curves to illustrate, describe the effects of the following events on the price level and on equilib rium GDP in the long run assuming that input prices fully adjust to output prices after some lag: a. An increase occurs in the money supply above potential GDP b. GDP is above potential GDP, and a decrease in govern- ment spending and in the money supply occurs c. Starting with the economy at potential GDP, a war in the Middle East pushes up energy prices temporarily. The Fed expands the money supply to accommodate the inflation. 5.5 [Related to the Economics in Practice on p. 227] The Economics in Practice describes the simple Keynesian AS curve as one in which there is a maximum level of out- put given the constraints of a fixed capital stock and a fixed supply of labor. The presumption is that increases in demand when firms are operating below capacity will result in output increases and no input price or output price changes but that at levels of output above full capacity, firms have no choice but to raise prices if demand increases. In reality, however, the short-run AS curve isn't flat and then vertical. Rather, it becomes steeper as we move from left to right on the diagram. Explain why. What circumstances might lead to an equ librium at a very flat portion of the AS curve? At a very steep portion? 0 Yo Aggregate output (income). Y 5.2 Two separate capacity constraints are discussed in this chapter: (1) the actual physical capacity of existing plants and equipment, shown as the vertical portion of the short-run AS curve, and (2) potential GDP, leading to a vertical long-run AS curve. Explain the difference between the two. Which is greater, full-capacity GDP or potential GDP? Why? 5.3 During 1999 and 2000, a debate raged over whether the United States was at or above potential GDP. Some econo- mists feared the economy was operating at a level of out- put above potential GDP and inflationary pressures were building. They urged the Fed to tighten monetary policy and increase interest rates to slow the economy. Others argued that a worldwide glut of cheap products was caus- ing input prices to be lower, keeping prices from rising,