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QUESTION:
The following graph shows the aggregate demand curve (AD), the short-run aggregate supply curve (AS), and the long-run aggregate supply curve (LRAS) for a hypothetical economy. Initially, the expected price level equals the actual price level, and the economy experiences long-run equilibrium at a natural level of output of $110 billion.
Suppose a bout of severe weather drives up agricultural costs, increases the costs of transporting goods and services, and increases the costs of producing goods and services.
Use the graph to help you answer the questions about the short-run and long-run effects of the increase in production costs that follow. (Note: You will not be graded on any adjustments made to the graph.)
Hint: For simplicity, ignore any possible impact of the severe weather on the natural level of output.
The short-run economic outcome resulting from the increase in production costs is known as.
Suppose now that the government decides not to take any action in response to the short-run impact of the severe weather.
In the long run, given that the government does nothing, the output level in the economy will equalbillion and the price level will equal.
ANSWER:
The short-run economic outcome resulting from the increase in production costs is known asstagflation.
Points:
1 / 1
Close Explanation
Explanation:
Firms experience higher production costs due to the severe weather. The increase in costs makes the sale of goods and services less profitable, so firms reduce the quantity of output they supply at each price level, causing the short-run aggregate supply curve to shift leftward and moving the economy from an output of $110 billion to $105 billion in the short run. Output falls below the natural level of output, and the price level increases from 110 to 115. The combination of stagnation (falling output) and inflation (rising prices) is known as stagflation.
Suppose now that the government decides not to take any action in response to the short-run impact of the severe weather.
In the long run, given that the government does nothing, the output level in the economy will equal
$110
billion and the price level will equal
115
.
Points:
0.5 / 1
Close Explanation
Explanation:
When the government takes no action in response to a negative aggregate supply shock, the higher price level may prompt workers to demand higher nominal wages, which, in turn, leads to a still higher price level, and a wage–price spiral occurs. In the short run, the wage–price spiral leads to even higher costs, shifting the short-run aggregate supply curve even farther to the left.
Eventually, however, the spiral of rising wages and prices will slow as output falls far below the economy's natural level of output and natural rate of employment levels decline. The slack in labor and resource markets will put downward pressure on wages and prices as the economy transitions from the short run to the long run. As wages fall, the short-run aggregate supply curve shifts to the right. In the long run, the price level will return to the original level of 110, and the quantity of output will return to the natural level of output of $110 billion.
.