Question

The economy is in long-run macroeconomic equilibrium when the point of short-run macroeconomic equilibrium is on the long-run aggregate supply curve. Using a graph, depict and explain the short-run versus long-run effects of:

I. A contractionary monetary policy resulting in demand shock on the long-run macroeconomic equilibrium. Use one contractionary monetary policy to illustrate your analysis, explain the nature of the policy and clearly depict the direction of the shift and changes in the equilibrium point, where necessary.

II. An expansionary fiscal policy resulting in demand shock on the long-run macroeconomic equilibrium. Use one expansionary monetary policy to illustrate your analysis, explain the nature of the policy and clearly depict the direction of the shift and changes in the equilibrium point where necessary.

III. A negative demand shock on the long-run macroeconomic equilibrium. Clearly depict the direction of the shift and changes in the equilibrium point, where necessary

Answer 1

LRAS SRAS luice I let the economy is initially at equilibrium y point E. A Contractionary monetary (I) policy will shift the & AD aurre Lend ? leftwards to AD and short run equilibrium occurs at Eg 44 - where prices and As output falls. This increases unemployment, reduces L wages and in long run SRAS shifto Not Output x right words to SRAS with new equilibrium at E . where prices fall to op and Output returns to yt. (Eg! Increase in reserve requirements) I. A expansionary fiscal policy r . SRAT leg. increase in Government fuice, f . will shift AS expenditure) level itt a to AD and thus prices and This reduces (I) L Output increases. rate and increases unemployment LRAS SRAS! SRAS wage rate shifting SRAs to SRAS' and long run equilibrium o occurs at & boint 6 where prices haud 2 Outh t risen to OP and Output is at off. I. The impact of negature demand shock will shift A leftwards and the diagram and explanation remains same as part (a)kI) depicted in diagram (I.).