1. Aggregate Demand/Aggregate Supply
a. Draw and aggregate demand and short run aggregate supply on the axes below. Label aggregate demand AD1 and aggregate supply AS1. Mark the equili
ium point and label it “A”. Mark both the price level and the level of output/GDP at point A.
. Suppose the economy is below full employment. Draw the long run aggregate supply and label it LRAS in the appropriate location on your graph relative to point A. Mark the output level co
esponding to the LRAS.
c. Now suppose the government increases government expenditures in an effort to drive the economy to full employment. Will the government’s action cause a shift in AD, AS or both?
d. Graph the effect of an increase in government expenditures, assuming the increase is sufficient to push the economy to full employment. Label the new graph #2 and label the new equili
ium point “B”.
e. What has happened to the price level and the level of output as a result of the increase in government expenditures?
2. Aggregate Expenditure-Income Model
The components of planned aggregate expenditure are as follows (all expenditure figures in billions of dollars):
• Autonomous consumption =$1100
• Autonomous Investment = 200
• Autonomous Government Spending = 150
• Autonomous Net Exports = -50
• Autonomous Taxes = 100
• Marginal Propensity to Consume = 0.6
a. What is the equation for the consumption function?
. What is the marginal propensity to save?
c. Find the equili
ium level of GDP (y)
d. Regardless of your answer in part c., suppose the business sector cuts investment spending by $50. What will be the impact on equili
ium GDP?
3. AE-Y Model linkage to AD-AS Model
Suppose planned aggregate spending may be represented by the following equation:
AE = XXXXXXXXXXy-T), where T = 200
a. Find the equili
ium level of GDP (y)
. What is the value of the tax multiplier?
c. Suppose potential GDP (the full employment level of GDP) is $10,000. What is the size of the gap between cu
ent GDP and potential GDP?
d. By how much must taxes be cut
aised to close the gap?
e. On the following graph, assume the aggregate supply curve is horizontal. Graph the aggregate supply. Next graph Aggregate Demand co
esponding to your answer in part a. Label it AD1 and label the intersection of AS and AD1 with the capital letter ‘A’. Show the equili
ium level of GDP on the horizontal axis. Next, graph the new aggregated demand curve co
esponding to your answer in part d. Label it AD2 and label the intersection between AD2 and AS as ‘B’. Show the level of GDP on the horizontal axis.
f. Although the AS shown in the graph is horizontal, aggregate supply typically slopes up (positive slope). Explain and show graphically why the economy will not experience the full effect of the tax cut above when aggregate supply slopes up.
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