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quanda36 - Chapter 36 1 Use the aggregate supply and...

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Practice Questions to accompany Mankiw & Taylor: Economics 1 Chapter 36 1. Use the aggregate supply and aggregate demand diagram in Exhibit 1 to answer the following questions. Exhibit 1 a. Suppose the economy is at long-run equilibrium at point A. Suppose that the economy suffers a macroeconomic shock in the form of a reduction in demand for its exports, but the shock is asymmetric – other economies are not affected similarly. If the exchange rate can adjust, what is the path followed by the economy as a result of this shock? Answer: The aggregate demand curve shifts to the left, from AD 1 to AD 2 , moving the economy initially to point C. Output falls and unemployment rises. Since demand for the country’s exports has fallen, the foreign exchange value of the country’s currency falls, making the country’s exports cheaper to overseas buyers. This raises aggregate demand, so shifting the aggregate demand curve back from AD 2 to AD 1 . Thus long-run equilibrium is restored at point A, with output and the price level unchanged from their original levels.
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