Business Economics (BEO6600) : Assignment

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Business Economics (BEO6600)STRUCTURED HOMEWORK ASSIGNMENT SET (4)CHAPTER 33 AD-AS, QUESTIONS FOR REVIEW 3, 5 & 6QUESTION 3List and explain the three reasons the aggregate demand curve slopes downward.The aggregate demand curve slopes downward for three reasons:1.The inflation rate and consumption: the wealth effect2.The inflation rate and investment: the interest-rate effect3.The inflation rate and net exports: the exchange-rate effect.1.The inflation rate and consumption: the wealth effectWhen the price level increases, the real value of money reduces and makes consumerpoorer. It also reduces the quantity of goods and services demanded as the consumerspending decreases because of the rise in the price level. Likewise, when the pricelevel decreases, the real value money increase and makes consumers better off. As aresult they spend more on goods and services which means goods and servicesdemanded rises.2.The inflation rate and investment: the interest-rate effectWhen the price level increases, more money is needed to make purchases and pay forinputs. The increased demand for it will drive up its price, the rate of interest. Thesehigher rates will decrease the buying of goods with borrowed money, thus decreasingthe amount of real output demanded. A lower price level reduces the interest rate,encourages greater spending on investment goods, and thereby increases the quantityof goods and services demanded.3.The inflation rate and net exports: the exchange-rate effectAs the United States’ price level rises relative to other countries, Americans will buymore abroad in preference to their own output. At the same time foreigners, findingAmerican goods and services relatively more expensive, will decrease their buying ofAmerican exports. Thus, with increased imports and decreased exports, American netexports decrease and so, therefore, does the quantity demanded of American realoutput.When a fall in the United States’ price level causes U.S. interest rates to fall,the real value of the dollar declines in foreign exchange markets. With thisdepreciation, U.S. net exports rises and thereby increases the quantity of goods andservices demanded.QUESTIONS 5List and explain the three theories for why the short run aggregate supply curve slopesupward.The aggregate-supply curveshows the quantity of goods and services that firms choose toproduce and sell at each inflation rate. Following theories explain why the short runaggregate supply curve slopes upward.1
Business Economics (BEO6600)1.The new classical misperceptions theoryMisperceptions about relative prices caused due to a lower price level. It results insuppliers to decrease the quantity of goods and services supplied in order to respondthe lower price level.2.The Keynesian sticky-wage theoryA lower price level makes employment and production less profitable because wagesdo not adjust immediately to the price level, so firms reduce the quantity of goods andservices supplied;3.The new Keynesian sticky-price theoryFirms with higher-than-desired prices effect due to an unexpected fall in the pricebecause not all prices adjust immediately to changing conditions. This will results inreduce sales and induces firms to reduce the quantity of goods and services theyproduce.QUESTIONS 6What might shift the aggregate-demand curve to the left? Use the model of aggregatedemand and aggregate supply to trace through the short-run and long-run effects ofsuch a shift on output and the price level.Situations when aggregate Demand Curve shifts to the left:1.Changes in Consumption: Aggregate Demand curve shifts to the left when an eventthat causes consumers to spend less at a given price level such as people desire toincrease saving.2.Changes in Investment: Aggregate Demand curve shifts left when an event causesfirms to invest less at a given price. This might be increase in interest rate due todecreasing money Supply. For example: increased taxes on the returns to investment.3.Changes in government purchases: when decrease in government purchases on goodsand services shift aggregate demand curve to the left like a cutback in defencespending.4.Changes in net export: aggregate demand curve shifts left when an event that reducesspending on government net exports at a given price level. This could be due to arecession in overseas and speculation that causes an exchange rate.The diagram below shows the trace through the short run and long run effects of such a shifton aggregate demand. The economy starts at equilibrium at point E1, intersecting short runAS1 and AD1. When the Aggregate demand curve shifts to the left to AD2, the economymoves from E1 to E2 with reducing price level and quantity of output. During this periodpeople try to adjust their perceptions, wages, and prices, shifting the short-run aggregatesupply curve down to AS2 and moving the economy from point E2 to point E3, which isagain back on the long-run aggregate supply curve and has a lower price level.2
Business Economics (BEO6600)CHAPTER 33PROBLEMS AND APPLICATION: 1, 2 & 8QUESTION 1Suppose the economy is in a long-run equilibrium.a.Draw a diagram to illustrate the state of the economy. Be sure to show aggregatedemand, short-run aggregate supply, and long-run aggregate supply.b.Now suppose that a stock market crash causes ag- aggregate demand to fall. Useyour diagram to show what happens to output and the price level in the shortrun. What happens to the unemployment rate?c.Use the sticky-wage theory of aggregate supply to explain what will happen tooutput and the price level in the long run (assuming there is no change in policy).What role does the expected price level play in this adjustment? Be sure toillustrate your analysis in a graph.a)Figure below illustrates the state of the economy. The aggregate demand, short-runaggregate supply and the long-run aggregate supply curve is clearly marked on thegraph. The aggregate demand and short-run aggregate supply curve intersect at thesame point on the long-run aggregate supply curve.3
Business Economics (BEO6600)b)A stock market crash causes aggregate demand to shift left from AD1 to AD2 in theshort run. The equilibrium level of output and price level will fall from point A to B toin the short run as shown in the diagram. When output is less than the natural rate ofemployment, the unemployment rises.c)In the long run, if the cost of labour remains unchanged with the fall in the price level,production will be less profitable and firms hires fewer workers and reduces thequantity of output supplied. Overtime, the short-run aggregate supply curve shift tothe right, moving the economy back to the natural rate of output as shown in thediagram.QUESTION 2Explain whether each of the following events will increase, decrease, or have no effecton long-run aggregate supply.a.The United States experiences a wave of immigration.b.Congress raises the minimum wage to $10 per hour.c.Intel invents a new and more powerful computer chip.d.A severe hurricane damages factories along the East Coast.a.Long-run aggregate supply increases as the labor force increases.b.Long-run aggregate supply decreases as the rate of unemployment rises.c.Long-run aggregate supply increases as more output can be produced with the sameinputs.d.Long-run aggregate supply decreases as the capital stock is smaller.4
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