macro economics

Ans 1(a) If the Central Bank within the economy lifts (raises) interest rates, then it reduces investment spending which in turn decreases aggregate expenditure and hence shifts the AD curve downwards to AD2. This decreases the price level to P2 and the output to Y2 in the short run. But in the long run the AS curve also shifts downwards to AS2, as the expected prices are revised downwards in response to low actual prices, and wage contracts are reformulated. Final long run equili
ium is again attained at full employment level Yf and lower overall price level P3.
Price level
AS1
AS2
P1
AD1
P2
P3
AD2
Y2
Yf
Output
(b)
If there is an increase in private domestic investment spending, then it increases aggregate expenditure and hence shifts the AD curve upwards to AD2. This increases the price level to P2 and the output to Y2 in the short run. But in the long run the AS curve also shifts upwards to AS2, as the expected prices are revised upwards in response to high actual prices, and wage contracts are reformulated. Final long run equili
ium is again attained at full employment level Yf and higher overall price level P3.
Price level
AS2
AS1
P3
P2
AD2
P1
AD1

Yf
Y2 Output
c) An increase in international oil prices, can cause stagflation in the economy as the entire cost structure in the economy increases which shifts the AS curve significantly and continuously upwards along a given AD curve and causes a permanent increase in price level and decline in full employment output to Yf’ and Yf’’, and increase in structural unemployment.
Price level
AS3

AS2
AS1
P3
P2

P1
AD1
Yf’’ Yf’
Yf
Output
d) An appreciation in the foreign exchange rate value of the economy’s cu
ency decreases exports and increases imports. It reduces aggregate expenditure and hence shifts the AD curve downwards to AD2. This decreases the price level to P2 and the output to Y2 in the short run. But in the long run the AS curve also shifts downwards to AS2, as the expected prices are revised downwards in response to low actual prices, and wage contracts are reformulated. Final long run equili
ium is again attained at full employment level Yf and lower overall price level P3.
Price level
AS1
AS2
P1
AD1
P2
P3
AD2
Y2
Yf
Output
e) A fall in real estate prices in the capital cities of the country which reduces one’s wealth level reduces household consumption expenditure and hence shifts the AD curve downwards to AD2. This decreases the price level to P2 and the output to Y2 in the short run. But in the long run the AS curve also shifts downwards to AS2, as the expected prices are revised downwards in response to low actual prices, and wage contracts are reformulated. Final long run equili
ium is again attained at full employment level Yf and lower overall price level P3.
Price level
AS1
AS2
P1
AD1
P2
P3
AD2
Y2
Yf
Output
f) The country main exports fall in price while the goods the country imports from a
oad rise in price. This would increase exports and decrease imports, which in turn would increases aggregate expenditure and hence shifts the AD...