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Refer to point A
c. [optional] Is there a strong need for using a fiscal expansion to return output to Y*? Explain why
or why not. A negative AS shock led to opening a recessionary output gap. With this output gap
economic costs are unavoidable, such as higher unemployment, lower incomes, and many
In addition, the adjustment process conducted by a private sector after the recessionary
gap would be very slow possibly due to downwardly sticky wages. Thus, those economic
costs will be accumulated for years.
Therefore, there would be a strong need of the fiscal stabilization policy that close and
shorten would-be-lasting recessionary output gap.
d. Assume that the Japan’s economy adjusts to a new long-run equilibrium after the disruptions of
Japan’s power and water supplies. (assume that there is no government policy implemented)
i. Explain the process by which the economy will adjust back toward Y* and why the shift of
SRAS curve would be slow. After the negative AS shock that opened a recessionary output gap, there would be lower
demand for labours and other factors. Then, nominal wages and other factor prices are
forced to be lower. The reduction in input prices provides lower unit costs to most of
industries in Japan. Therefore, SRAS gradually increases until Y returns to Y*. However,
this process would be very sluggish due to the downwardly-sticky wage.
ii. Refer to your answer in part(d)(i), draw the new SRAS curve and label the new long-run
equilibrium output and price level as Y2 and PL2 in the diagram in part (a).
Refer to point B
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This note was uploaded on 01/20/2014 for the course ECON 105 taught by Professor Hanafiahharvey during the Summer '08 term at Simon Fraser.
- Summer '08
- Macroeconomics, Assignments