Ch. 10 - Winter 2009 ECN101 Intermediate Macroeconomics...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
ECN101 Intermediate Macroeconomics Winter 200 9 Professor E.A.Frenkel Homework 1 0 – Solutions (1) Your economy is running at less than full employment equilibrium. You decide to increase the money supply to raise the level of income. What happens immediately on your diagram as "M" rises? What might happen next to the price expectations that suppliers factor into their supply decisions? What happens on the diagram once price expectations change? Was your decision to increase the money supply successful? There is no one right answer here, just the right logic and you work through your scenario. Solution: The economy starts at point A, where the output is below the natural level. If the government increases money supply, what happens immediately on the diagram is the aggregate demand would shift to the right, from AD 1 to AD 2 , causing output to increase and price to rise, the economy could be at point B. However, in a while, people’s (suppliers’) expectations of price level would increase as well, to catch up with the reality. Once the expected price level increases, the short-run aggregate supply curve would shift to the left (note that each short-run aggregate supply curve is drawn for a given expectation P e and a change in P e would shift the curve), and may continuing shifting if the expected price level is higher and higher. The economy could slip into a recession with high inflation, for example, at point C. Therefore, in the case of a growing inflation expectation, your decision to increase M is not very successful. (2) Your economy is at full employment equilibrium. A supply shock hits the economy and this raises the expectations that the future price level will be higher than it is at present. What happens to employment and what can you do to protect it? B P 3 P 1 C AD 2 Price level, P Y 1 ± A Output,Y AD 1 SRAS 1 LRAS SRAS 2 Figure 1 P 2
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Solution: The economy is originally at point A, where it is at full employment equilibrium. A supply shock hits the economy and raises the prices. As P e increases, the short-run aggregate supply curve shifts to the left, and may continue shifting to the left if the expectations of higher price level is not corrected over time. As a result, output falls, price rises, the economy could be at point B for example. The unemployment rate rises together with the inflation is high.
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 7

Ch. 10 - Winter 2009 ECN101 Intermediate Macroeconomics...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online