Chapter 20, Problem 7PA

Sub part (a):

To determine

Impact of different views on inflation on the economy's equilibrium.

Explanation of Solution

The supply is dependent upon the price level in the economy. When the price level is higher, the suppliers will be receiving higher income, and this would incentivize them to increase the supply in the economy and vice versa. The aggregation of the supply curves of all the firms in the economy is known as the aggregate supply curve. In the short run period, the aggregate supply curve represents the relationship between the price level in the economy and the supply by the firms.

The demand comes from all the economic agents such as the households, firms, and the government. The demand depends on the price level of the economy. The increase and decrease in the price level determine the level of demand in the economy. The aggregation of all the individual demands in the economy is known as the aggregate demand; thus, the aggregate demand explains the relationship between the general price level and the level of real GDP demanded in the economy by the economic agents such as the households, firms, and the government.

When the new chairman is one with the view that the inflation is not a big issue on the economy, the economy would identify the chairman as the silent supporter of the inflation, and they will expect that the chairman will not introduce the active policies to fight against and control the inflation in the economy. As a result, the public will expect that the rise in the inflation and the price level are likely to rise.

Economics Concept Introduction

Concept introduction:

Aggregate demand curve: It is the curve that shows the relationship between the price level in the economy and the quantity of real GDP demanded by the economic agents such as the households, firms, and the government.

Aggregate supply curve: In the short run, it is a curve that shows the relationship between the price level in the economy and the supply in the economy by the firms. In the long run, it shows the relationship between the price level and the level of quantity supplied by the firms.

Equilibrium: The equilibrium in the economy is the point where the economy's aggregate demand curve and the aggregate supply curve intersect with each other. There will be no excess demand or excess supply in the economy at the equilibrium.

Sub part (b):

To determine

Impact of different views on inflation on the economy's equilibrium.

Explanation of Solution

When the people expect higher inflation for the next year, they will start to calculate the changes in the price level. According to the expected higher level of inflation over the next year, they will expect higher cost of living for the next year. As a result of this, they will demand higher nominal wage rate for the next year with the employers.

Economics Concept Introduction

Concept introduction:

Aggregate demand curve: It is the curve that shows the relationship between the price level in the economy and the quantity of real GDP demanded by the economic agents such as the households, firms, and the government.

Aggregate supply curve: In the short run, it is a curve that shows the relationship between the price level in the economy and the supply in the economy by the firms. In the long run, it shows the relationship between the price level and the level of quantity supplied by the firms.

Equilibrium: The equilibrium in the economy is the point where the economy's aggregate demand curve and the aggregate supply curve intersect with each other. There will be no excess demand or excess supply in the economy at the equilibrium.

Sub part (c):

To determine

Impact of different views on inflation on the economy's equilibrium.

Explanation of Solution

The profit of the firm is the difference between the total cost and the total revenue of the firm's products. When the total cost is higher than the total revenue, the firm faces the loss and if it is vice versa, the firm earns the profit. When the nominal wages increase, it increases the cost of production. So at any given price point, the increase in the labor cost reduces the profitability of the firm because it increases the total cost of production of the firm.

Economics Concept Introduction

Concept introduction:

Aggregate demand curve: It is the curve that shows the relationship between the price level in the economy and the quantity of real GDP demanded by the economic agents such as the households, firms, and the government.

Aggregate supply curve: In the short run, it is a curve that shows the relationship between the price level in the economy and the supply in the economy by the firms. In the long run, it shows the relationship between the price level and the level of quantity supplied by the firms.

Equilibrium: The equilibrium in the economy is the point where the economy's aggregate demand curve and the aggregate supply curve intersect with each other. There will be no excess demand or excess supply in the economy at the equilibrium.

Sub part (d):

To determine

Impact of different views on inflation on the economy's equilibrium.

Explanation of Solution

When the profitability of the firm decreases due to the increased nominal wage rate of the labor, the supply will decline in the economy, which will cause the short run aggregate supply curve to shift upward and this can be illustrated on the graph as follows:

Economics Concept Introduction

Concept introduction:

Aggregate demand curve: It is the curve that shows the relationship between the price level in the economy and the quantity of real GDP demanded by the economic agents such as the households, firms, and the government.

Aggregate supply curve: In the short run, it is a curve that shows the relationship between the price level in the economy and the supply in the economy by the firms. In the long run, it shows the relationship between the price level and the level of quantity supplied by the firms.

Equilibrium: The equilibrium in the economy is the point where the economy's aggregate demand curve and the aggregate supply curve intersect with each other. There will be no excess demand or excess supply in the economy at the equilibrium.

Sub part (e):

To determine

Impact of different views on inflation on the economy's equilibrium.

Explanation of Solution

When the aggregate demand is held constant without any change and the aggregate supply shifts to AS2 as given above, it will lead to lower output in the economy along with higher price level in the economy. This is because when the SRAS curve shifts upward, the new equilibrium will be derived at point B, which is lying above and leftward to the initial equilibrium point A.

Economics Concept Introduction

Concept introduction:

Aggregate demand curve: It is the curve that shows the relationship between the price level in the economy and the quantity of real GDP demanded by the economic agents such as the households, firms, and the government.

Aggregate supply curve: In the short run, it is a curve that shows the relationship between the price level in the economy and the supply in the economy by the firms. In the long run, it shows the relationship between the price level and the level of quantity supplied by the firms.

Equilibrium: The equilibrium in the economy is the point where the economy's aggregate demand curve and the aggregate supply curve intersect with each other. There will be no excess demand or excess supply in the economy at the equilibrium.

Sub part (f):

To determine

Impact of different views on inflation on the economy's equilibrium.

Explanation of Solution

The situation explained above that the total output of the economy falls, whereas the price level in the economy increases leading to the situation of stagflation and this means that the appointment choice of the new chairman was not a wise choice.

Economics Concept Introduction

Concept introduction:

Aggregate demand curve: It is the curve that shows the relationship between the price level in the economy and the quantity of real GDP demanded by the economic agents such as the households, firms, and the government.

Aggregate supply curve: In the short run, it is a curve that shows the relationship between the price level in the economy and the supply in the economy by the firms. In the long run, it shows the relationship between the price level and the level of quantity supplied by the firms.

Equilibrium: The equilibrium in the economy is the point where the economy's aggregate demand curve and the aggregate supply curve intersect with each other. There will be no excess demand or excess supply in the economy at the equilibrium.