Draw diagram illustrating situation using the ad model- Microeconomics
1. Suppose an economy is initially in both long run and short run equilibrium. Assume in the short run prices are completely sticky and in the long run prices are completely flexible.
a. Draw a diagram illustrating this situation using the AD/AS model. In your diagram make sure you include the LRAS, the SRAS, the AD, and the initial equilibrium aggregate price level (P) and the initial equilibrium aggregate output level (Y).
b. Suppose that this economy experiences a positive aggregate demand shock so that at every price level there is greater demand for goods and services. Draw a graph showing the new short run equilibrium (Y’, P’) for this situation. Label your graph clearly and completely.
2. You are given the following information. The money supply in your economy is equal to $50,000 and the velocity is constant and equal to 5.
a. Using the quantity theory derive an equation for the AD curve where aggregate output Y is expressed in terms of the aggregate price level P, or in other words where Y = f(P).
b. Suppose velocity increases to 10, describe verbally what will happen to the AD curve.
c. Provide an equation for the new AD curve, AD’,using the information given in part (b). Write this equation in the form that Y is expressed in terms of the aggregate price level P, or in other words where Y = f(P).
d. Draw a sketch of these two demand curves in the space below. Label your sketch clearly and carefully.
e. Now, suppose that the long run aggregate production in this economy can be described using a Cobb-Douglas production function that exhibits constant returns to scale. You know that labor’s share of income is 50% and that initially this economy has 400 units of capital, 625 units of labor, and a measure of technology equal to 50. What is the long run natural rate of output for this economy? Show your work.
f. What is the aggregate price level (P) for this economy given the information in (e) and the initial aggregate demand curve you found in part (a)? Show your work.
g. What is the new aggregate price level (P”) for this economy given the information in (e) and the second aggregate demand curve (the one from parts b and c) you found. Show your work.
h. Draw a sketch illustrating these two equilibria. Label your graph clearly and completely.
