Jose Escobar

2

Describe the following events in terms of the AD-SRAS diagram, and explain what happens to GDP, the price level and unemployment in each case:

STas0

ad0

STas1

pp1p2

1. An increase in interest rates causes house prices to plummet and consumer wealth to decrease

Assuming that the economy start in point A, a decrease in the consumer wealth will generate a decrease in “ad” that will move the price to p1, in the short term “as” will react decreasing production and this will generate a new level of unemployment y1 setting in “B”.

ad1

y1 y0

A

CB

2. Labour unions recognize that prices have generally fallen and agree to a 2% cut in wages across the board

Almost a continuation of the previous question. Assuming that you the economy start in point B. Wages will decrease allowing full employment and setting in “C” with price p2 and with the long term “as” production level.

3

Describe the following events in terms of the AD-SRAS diagram, and explain what happens to GDP, the price level and unemployment in each case:

STas0

ad0

STas1

pp1

3. The discovery of new and more efficient methods in manufacturing causes the cost of production to fall in essential sectors

New and more efficient technology will make the short term “as” to move to the right decreasing price and increasing production, finding a new equilibrium in point B. My question is that if in the long run the “as” will find a new long term level of production in the same point “B”?

y1y0

AB

4. The approval rating of the government falls sharply due to weakness in the economy, and elections are due in 12 months. The government decides to implement a broad-based spending programme.

This government spending increase will move the “ad” to the right increasing prices and increasing production to settle in point B; in the long run the overtime to produce more (increase in wages) will make the “short term as” to move to the left and find equilibrium at C with a higher price and the same level of production that in the long term “as”.

STas0

ad0

STas1

pp1

p2

ad1

y1y0

A

CB