Question

1. Labour Market. Draw a diagram of the labour market where there above the equilibrium level. Use I to denote the amount of labour to denote the amount of labour hired. bour market where the real wage is stuck note the amount of labour willing to work and L1 Now suppose there is an increase in technology that raises the demand the new demand curve and explain what happens to the and curve and explain what happens to the number of unemployed as a result of the change. hnology that raises the demand for labour. Draw 4. AD/SRAS/LRAS. Draw an AD/SRAS/LRAS diagram that illustrates the economy currently in long run equilibrium. Now suppose there is an AD shock, such as the introduction of credit cards, that shifts the AD curve to the right. Illustrate graphically and explain verbally how the economy moves to the new long run equilibrium. 3. AD/SRAS/LRAS. Draw an AD/SRAS/LRAS diagram that illustrates the economy currently in long run equilibrium. Now suppose there is an adverse supply shock that pushes up costs and prices, Illustrate graphically and explain verbally how the economy moves to the new long run equilibrium 4. Money Market. Draw a diagram that illustrates equilibrium in the money market. Now suppose the Bank of Canada increases the money supply, illustrate graphically and explain verbally how the money market moves to a new equilibrium. You are not logged in.

Answer 1

1. Demand for labour is an inverse function of the real wage rate. At a higher wage rate less workers are demanded and at lower wage rate more workers are demanded. The demand for labour is inversely related to the wage rate. The supply of labour is also function of real wage rate. At a higher wage rate more workers are willing to work. But at low wage rate less workers are willing to work. The supply of labour is a direct function of the wage rate. In any situation if the wage rate is above the equilibrium the supply of labour exceeds the demand for labour. The workers hired at this level will be less than the workers willing to work. Real Wage Amount of labour The equilibrium wage rate is W where number of workers demand and supplied is equal to L. Suppose the wage rate increase above the equilibrium say to W* Al this higher wage rate the number of workers hired is Ll but the number of workers willing to work is L. There is an excess supply of labour equal to LI L. A technological improvement increases the demand for labour. Thus more workers are hired. The demand curve of workers shifts to the right. Real Wage D1 Li L Amount of labour The improvement in technology shifts the demand curve of labour to the right from D to D1. Then at the prevailing wage rate the excess workers in the market will be ſully absorbed. The market again reaches to the equality of demand for labour and

supply of labor. But the wage rate will stay at W. Those who are willing to work will be fully employed. Price level LRAS SRASI L SRAS VADI AD YfY GDP The economy is currently in longrun equilibrium at point 'E' with fullemployment output Yf and price level PL. The positive demand shock shift the aggregate demand curve to the right from AD to AD1. Then in shortrun price level increase to PL1 and aggregate output increase to Y1. The economy moves to the shortrun equilibrium at El. In shortrun the economy suffers from inflationary gap. But the economy will be self corrected to the longrun equilibrium through wage price adjustment. The high price level reduces the real wage of the workers. With the given nominal wage the workers now able to purchase less. Then workers demand more wages. Thus the work contracts and resource contracts were signed in uccordance to the increased price level of Pll. This increased resource price increase the cost of production. As the cost increase the lirms reduce the volume of output. Thus the SRAS curve shift to the left from SRAS to SRASI. The economy move to the longrun equilibrium at E2 where it moves back to the potential output at Yf. But the price level will be PL2. Price level LRAS SRASI SRAS PL --EN AD1 AD Yi YI GDP The economy is in longrun equilibrium at point 'E'. The adverse supply shock shift the AS curve to left from SRAS to SRASI. The price level increase to PL1. This high price level reduces the aggregate demand and hence the price level starts to come down. The fall in price level and increased unemployment among the workers compel them to accept a low wage. As the resource price falls aggregate

supply increase and it continues till the economy reaches to its fullemployment at Yf. MS MSI Ril - M MI The money market is in equilibrium with the demand for money is equal to the supply of money. The supply of money is interest inelastic. It is determined by the central bank by its discretionary power. Hence the supply curve of money is a vertical line. But the demand for money is interest elastic. At a lower rate of interest more money is demanded and at higher rate of interest less money is demanded. Hence the demand curve of money is a downward sloping curve. If the central bank increase the money supply, the money supply curve shift from MS to MS1 and the rate or interest fall to R1 and the fall in interest rate increase the demand for money and a new equilibrium will be established at R1 rate of interest and demand for and supply of money equal at MI.