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Unformatted text preview: Problem Set 5 Solutions Question 1 In the AD-AS framework, short run equilibriums occur where the AD intersects the SRAS. Long run equilib- riums occur where the AD intersects the LRAS. During the early 1970s, the recession in the US was caused by a supply shock (figure 1). When the supply shock hits, the LRAS shifts to the left. The SRAS shifts up to the long run equilibrium. In the case of a demand shock, we would have figure 2. In the short run, prices wouldnt change, but output would fall. In the long run, if demand persisted at this lower level, prices would fall to, and output would return to the full employment level. Question 2 Its simpler to approach this problem algebraically. Solve for the equilibrium values and then see how changing a particular parameter will change the equilibrium. This is called comparative statics. Desired Consumption: C d = a + b ( Y- T )- cr Desired Investment: I d = d- er Real Money Demand: L = fY- h ( r + e ) Full-Employment Output: Y = 4 ,...
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- Spring '07