Question

Assume that the potential GDP of the economy of Arlon is $1,500, and that the aggregate demand and aggregate supply are as shown in the following table. Aggregate Quantity Demanded 1 $1,900 1,800 1,700 1,600 1,500 1,400 1,300 1,200 1,100 1,000 Aggregate Quantity Price Index Aggregate Quantity Demanded 2 Supplied $1,100 1971,200 1 98 1,300 991 ,400 100 1,500 101 1,600 102 1,700 103 1,800 104 1,900 105 2,000 a. The value of equilibrium real GDP ISO and the price level is . There is (Click to select) v gap. The gap is equal to $ . b. If firms become more optimistic and aggregate demand increases by $200, complete the aggregate demand 2 column in the table above. c. The new value of equilibrium real GDP is and the price level is now . d. There is (Click to select) v gap. The gap is equal to $ (Click to select) an inflationary a recessionary

Answer 1

(a)

Equilibrium is attained at equality of aggregate quantity demanded and aggregate quantity supplied.

The aggregate quantity demanded equals the aggregate quantity supplied at level of real GDP of 1,500.

The price index corresponding to real GDP of 1,500 is 100

Thus,

The value of equilibrium real GDP is $1,500 and the price level is 100

The potential GDP is $1,500. The equilibrium real GDP is equal to potential GDP.

Thus,

There is no gap. The gap is equal to $0.

(b)

The firms become more optimistic and aggregate demand increases by $200.

Following is the complete table -

| Aggregate Quantity Demanded 1 $1,900 1,800 1,700 1,600 1,500 1,400 1,300 1,200 1,100 1,000 Aggregate Quantity Demanded 2 $2,100 2,000 1 | 1,900 1,800 1,700 1,600 1,500 1,400 1,300 1,200 Price Index 96 97 98 99 100 101 102 103 104 105 Aggregate Quantity Supplied $1,100 1,200 1,300 1,400 1,500 1,600 1,700 1,800 1,900 2,000

(c)

Equilibrium is attained at equality of aggregate quantity demanded and aggregate quantity supplied.

The aggregate quantity demanded equals the aggregate quantity supplied at level of real GDP of 1,600.

The price index corresponding to real GDP of 1,600 is 101

Thus,

The new level of equilibrium real GDP is $1,600 and the price level is now 101.

(d)

The potential GDP is $1,500. The new level of equilibrium real GDP is $1,600.

When the equilibrium real GDP exceeds the potential GDP then inflationary gap exists in the economy.

So,

There is an inflationary gap. The gap is equal to $100.