Problem Seven ATD3 ADa Assume the economy is in long run equ

Problem Seven: ATD3 ADa Assume the economy is in long run equilibrium at Point B If planned investment increases, where would the economy move in the short run? What would GDP growth, the unemployment rate, the CPl, the PPl, and capacity utilization be like? If no intervention happens, where would the economy be in long run equilibrium? What is undesirable about that outcome? Assume again that the economy is in long run equilibrium at Point B. Give three examples of changes (also known as shocks) that could shift the short term equilibrium to D. 1. 2.

Solution

We are assuming that economy is in a long run equilibrium at point B. Form this point if the planned investment increased, it will increase the demand in the economy and AD curve will shift to the right. New AD curve AD3 meeting supply curve at point E.

As in the short run, other variables are fixed and the firms, to increase production, can only increase the price to reduce the real wage and hire more labor the price level (cpi) will increase and firms will hire more labor at lower real wages reducing the unemployment in the economy. The economy will be functioning at more than normal output level.

IF no intervention happens then, in the long run, the labor will start demanding more wages because to hire more workers the firm has reduced the real wages by increasing prices. Increased wages will force the employment and output level back to the normal level. The economy will find a new equilibrium at point A. At this point, the price level is much higher than it was before i.e. point B and the output is same as before that means the money has lost some of its value.

(Second part)

Three shocks that could shift the equilibrium level to \"D\" are: