The following graph shows the short-run aggregate supply (SRAS) and aggregate demand (AD) curves for a fictional economy that is producing at point A (grey star symbol), which corresponds to the intersection of the AD₁ and SRAS, curves. PRICE LEVEL 140 130 120 110 100 the 90 80 70 60 7 LRAS SRAS SRAS, AD curve 13 According to the graph, actual output of this economy is 10 11 12 QUANTITY OF OUTPUT (Trillions of dollars) No Intervention Intervention Along SRAS₁, wages would have been negotiated based on an expected price level of. Since the actual price level at point A is 90, this means that real wages are ✓had been negotiated, which will ✓ unemployment. than potential output, which means that the economy experiences If the Fed does not intervene, these labor market conditions would cause nominal wages to Eventually, the economy would reach a new long-run equilibrium. shifting the On the previous graph, place the purple point (diamond symbol) at the new long-run equilibrium output and price level if the Fed intervenes. (Hint: Assume there are no feedback effects on the curve that does not shift.) Now, suppose the Fed chooses to intervene in an effort to move the economy more quickly back to its potential output. To do so, the Fed will the money supply, which will the interest rate, thereby giving firms an incentive to investment, shifting curve to the On the previous graph, place the green point (triangle symbol) at the new long-run equilibrium output and price level if the Fed does not intervene and successfully brings the economy back to long-run equilibrium. (Hint: Assume there are no feedback effects on the curve that does not shift.) Compare your answers to the previous few questions. If the Fed does not intervene, the economy will likely have relatively On
The following graph shows the short-run aggregate supply (SRAS) and aggregate demand (AD) curves for a fictional economy that is producing at point A (grey star symbol), which corresponds to the intersection of the AD₁ and SRAS, curves. PRICE LEVEL 140 130 120 110 100 the 90 80 70 60 7 LRAS SRAS SRAS, AD curve 13 According to the graph, actual output of this economy is 10 11 12 QUANTITY OF OUTPUT (Trillions of dollars) No Intervention Intervention Along SRAS₁, wages would have been negotiated based on an expected price level of. Since the actual price level at point A is 90, this means that real wages are ✓had been negotiated, which will ✓ unemployment. than potential output, which means that the economy experiences If the Fed does not intervene, these labor market conditions would cause nominal wages to Eventually, the economy would reach a new long-run equilibrium. shifting the On the previous graph, place the purple point (diamond symbol) at the new long-run equilibrium output and price level if the Fed intervenes. (Hint: Assume there are no feedback effects on the curve that does not shift.) Now, suppose the Fed chooses to intervene in an effort to move the economy more quickly back to its potential output. To do so, the Fed will the money supply, which will the interest rate, thereby giving firms an incentive to investment, shifting curve to the On the previous graph, place the green point (triangle symbol) at the new long-run equilibrium output and price level if the Fed does not intervene and successfully brings the economy back to long-run equilibrium. (Hint: Assume there are no feedback effects on the curve that does not shift.) Compare your answers to the previous few questions. If the Fed does not intervene, the economy will likely have relatively On
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:4. The long-run effect of Federal Reserve action (or inaction) in the AD-AS model
The following graph shows the short-run aggregate supply (SRAS) and aggregate demand (AD) curves for a fictional economy that is producing at
point A (grey star symbol), which corresponds to the intersection of the AD, and SRAS₁ curves.
(?)
PRICE LEVEL
140
130
120
110
100
the
8
8
70
60
6
LRAS
7
SRAS
SRAS,
AD₂
8
9
10
11
12
QUANTITY OF OUTPUT (Trillions of dollars)
curve
13
According to the graph, actual output of this economy is
AD
14
A
No Intervention
Intervention
Along SRAS₁, wages would have been negotiated based on an expected price level of. Since the actual price level at point A is 90, this means
that real wages are
had been negotiated, which will
unemployment.
than potential output, which means that the economy experiences
If the Fed does not intervene, these labor market conditions would cause nominal wages to
Eventually, the economy would reach a new long-run equilibrium.
shifting the
On the previous graph, place the purple point (diamond symbol) at the new long-run equilibrium output and price level if the Fed intervenes. (Hint:
Assume there are no feedback effects on the curve that does not shift.)
Now, suppose the Fed chooses to intervene in an effort to move the economy more quickly back to its potential output. To do so, the Fed will
the money supply, which will
the interest rate, thereby giving firms an incentive to
investment, shifting
curve to the
On the previous graph, place the green point (triangle symbol) at the new long-run equilibrium output and price level if the Fed does not
intervene and successfully brings the economy back to long-run equilibrium. (Hint: Assume there are no feedback effects on the curve that does not
shift.)
Compare your answers to the previous few questions. If the Fed does not intervene, the economy will likely have relatively
the other hand, if the Fed does intervene, it risks causing relatively
especially if it changes the money supply too much.
. On
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