Question

(e) According to the AS-AD model of the macroeconomy, expansions of the money supply are not “neutral” but rather they will have medium and long-term effects on output and employment. (f) The natural rate of unemployment is unaffected by policy changes. 13 (g) The aggregate supply relation implies that an increase in output leads to an increase in the price level. (h) The natural level of output can be determined by looking only at the aggregate supply relation. (i) The aggregate demand relation implies that an increase in the price level leads to an increase in output.

Answer 1

As per the Chegg Policy, answering the first four parts

(e)

An expansion in the money supply will have the following effects on the price level, output, and employment level in three different periods:

- Short Run Effect: In the short term, increase in the money supply causes investment to increase. Investment is the part of Aggregate demand. So, AD curve shifts to the right. As a result, the price, output and employment level will increase.

- Medium Run Effect: Prices will further increase. However, the output remains below the actual output obtained in the short run. So, in the medium run, the actual output is above the potential output but below the short run output level.

- Long Run Effect: Prices will increase further. Output and Employment will return back to the potential level.

Money Neutrality holds in the long run. It only affects the nominal variable like price and does not affect the real variable such as output and employment.

(f)

The natural rate of unemployment is unaffected by policy changes

False. The natural rate of unemployment might be affected by the policies of the government. For example, a government policy of job separation rate will surely affect the natural rate of unemployment

(g)

The aggregate supply relation implies that an increase in output leads to an increase in the price level

True. AS relation shows a positive relation between price and output. The AS curve is upward sloping. As output increases, the price level will also increase.

(h)

The natural level of output can be determined by looking only at the aggregate supply relation

True.

Following is the AS relation:

P = P^e (1+m)F(u,z)

where m is the mark up

z is catch all variable

m and z are assumed to be constant.

The natural rate output is governed by the natural rate of unemployment. At this natural rate of unemployment, the real wages (W/P) deterement by price setting and wage setting relations is equal. So, the AS relation determines the natural rates of output when the actual price (P) is exactly equal to the expected price level (Pe)