Question

2. Use an AD-AS diagram to analyze how each of the following economic scenarios will affect Y and P in both the short run and in the long run. In each case, begin with the assumption that Y is at its potential level YP, Be sure to indicate clearly in your diagram which curves shift and in what direction they shift (in both the short run and the long run.) Cle) (a) There is a increase in consumer confidence in the economy. (b) The federal government reduces its level of spending G in order to reduce current debt levels. (c) The Canadian dollar declines in value. (d) A fall in oil prices causes a large drop in energy and transportation costs.

Answer 1

a. (Fig 1 ) An increased consumer confidence reflects that people are confident about their money supply therefore they will be willing to spend more. Resulting in the shift in the demand curve.

AD2 ADI YJ fig-

B. (fig2) A large budget deficit increases AD (shown at equilibrium E1) here demand is so high that both pieces (P) and wages(Y) increase causing inflation. The govt. intrudes by reduction in its spending or tax raise which decreases the price by shifting AD1 to AD2 (where AD meets LRAS).

LRAS SRAS AD. EX AD y (fig. 2)

C. (fig3) A fall in value of currency refers to depreciation which means loss of value of a country's currency with respect to some foreign currency. Due to depreciation exports tend to rise leading to an increase in both Y & P.

SRAS AD2 ADI > fiag-3

4. Reduction in price of inputs (as in this case of drop in energy and transportation cost) leads to the shift of AS curve towards right i.e. increase in the supply. .

LRAS, LRAS SRAS2 E1 P2 AD Y, 2