1. Using aggregate demand, short-run aggregate supply, and long-run aggregate supply curves, explain the process and causes by which each of the following economic events will move the economy from one long-run macroeconomic equilibrium to another. In each case, explain the short-run and long-run effects on the aggregate price level and aggregate output. a. There is a decrease in households’ wealth due to a decline in the stock market.
A decrease in household wealth means lower purchasing power. The consumer reduces their consumption leading to a decline in the demand which shifts to the left from D1 to D2. As a result, in the short run both the output and aggregate price level fall as depicted by S1. A continued shift in the demand curve to the left, from D1 to D2, leads to reducing price and increasing supply which causes the supply curve to shift from S1 to S2. The long run equilibrium aggregate output and prices will remain constant. In the long run aggregate supply curve shifts to the right from S1 to S2 and the aggregate demand curve also shifts to the right from D1 to D2. The equilibrium aggregate output remains constant while the aggregate prices fall. The long equilibrium aggregate remains constant.
b. The government lowers taxes, leaving households with more disposable income, with no corresponding reduction in government purchases.
With the taxes lowered and the income still maintained, the consumers have more purchasing power. The demand for goods and services will therefore increase and shift from D1 to D2 resulting in an increase in aggregate prices and real GDP. In the long run real GDP is constant. In the short run the aggregate supply will shift to the left as aggregate demand increases and shifts to the right. In the long run aggregate prices will shift upwards while real GDP remains constant. In the long run both the demand and supply curves get new slopes. The aggregate demand curve...