Question

1. Use the AD-AS model to illustrate the impact of strikes on the general price level and the level of real production and income in the economy.

2. Using the Phillips curve, illustrate how cost-push inflation affects the relationship between unemployment and the inflation rate.

3. Use the AD-AS model to illustrate what the impact of an expansionary monetary policy instrument will be on the general price level and the level of real production and income in the economy.

Answer 1

$1.$

the AD-AS model

$\bull$ The AD-AS (aggregate demand-aggregate supply)

$\bull$ This model is a way of illustrating national income determination and changes in the price level.

$\bull$ We can use this to illustrate

phases of the business cycle and

$\bull$ how different events can lead to changes in two of our key macroeconomic indicators: real GDP and inflation.

In an AD/AS diagram,

$\bull$ long-run economic growth due to productivity increases over time is represented by a gradual rightward shift of aggregate supply.

$\bull$ The vertical line representing potential GDP—

the full-employment level of gross domestic product—

gradually shifts to the right over time as well.

$2$ .

Phillips curve

The Phillips curve shows the inverse trade-off between

rates of inflation and rates of unemployment.

$\bull$ If unemployment is high, inflation will be low; if unemployment is low, inflation will be high.

$\bull$ Phillips Curve and Aggregate Demand: As aggregate demand increases from AD1 to AD4,

$\bull$ the price level and real GDP increases.

The curve

$3.$

Impact of an expansionary monetary policy

$\bull$ An expansionary monetary policy will reduce interest rates and stimulate investment and consumption spending,

$\bull$ causing the original aggregate demand curve (AD₀) to shift right to AD₁, so that the new equilibrium (E₁) occurs at the potential GDP level of 700.

$\bull$ The aggregate demand/aggregate supply, or AD/AS,

$\bull$ model is one of the fundamental tools in economics because

$\bull$ it provides an overall framework for bringing economic factors together in one diagram.