AB 204 Unit 8 Assignment

AB204-02 Unit 8 Assignment

Kaplan University

April 24, 2017

Unit 8 Assignment

Long-run Macroeconomic Equilibrium and Stock Market Boom

Let us assume the economy reaches its long-run macroeconomic equilibrium in 2020. When the economy is in the long run macroeconomic equilibrium, the stock market will also reach its boom. This will in turn lead to increases in stock prices more than expected, and the stock prices will stay high for some period.

Answer the following questions based on the scenarios of long macroeconomic equilibrium and consequent stock market boom.

Which curve will shift? Is it AS curve or AD curve? In which direction does the shift occur?

In the short-run, what will happen to the price level and output (real GDP)?

What will happen to the expected price level? What impact does this have on wage bargaining power of workers?

In the long-run, which curve will shift due to the change in price expectations created by the stock market boom? In which direct will it shift?

How does the new long-run macroeconomic equilibrium differ from the original equilibrium?

(a) Since stock prices will boom, people will have more money power. This will increase the aggregate demand. The AD curve will shift to the right.

(b) In short run the price level increases, the GDP more or less remains the same. The real output falls due to increase in price level. Real GDP= Nominal GDP/ Price level

(c) The expected price level will increase further than the actual price. Since the price level has gone up, the workers will demand higher money wage. The short run supply will fall due to increased wage rate.

(d) The long run supply curve is vertical. The demand curve will shift to left showing a decrease in demand.

(e) The original equilibrium will be at higher prices and lower output.
2) Studies indicate that net exports and net capital outflows tend to be equal.

a) Why do net exports and net capital outflows tend to be equal? How does an increase in the price level change interest rates?

The net capital outflow and exports tend to be equal as for any purchase of exports in a country it must make transactions or trade on assets for currencies so as to make payments for exports, these payments made are equal to the net exports.

When there is increase in price level the purchasing power of people become less, thus they do not tend to lend money or deposit them in banks, this again leads to stringent measures of bank raising interest as they have very less deposits to lend.

b) How does this change in interest rates lead to changes in investment and net exports?

As and when there is rise in interest rates, the dollar supply in the market decreases as people invest less on foreign securities and this in turn leads to the rise of value of dollar which reduces the net exports.

3) Assume there is a decrease in the demand for goods and services, which leads to a decrease in the real GDP and eventually the economy into recession.

a) When the economy enters recession due to a decline in demand, what will happen to the price level?

When the economy enters recession due to decline in demand then even the price levels will decline.

b) Assume there is no government intervention. What will ensure that the economy still eventually gets back to the natural rate of output (real GDP)?

If the government do not intervene then the prices will fall drastically beyond the expected point by the people and they will start transacting in the lower price levels. This will eventually lead to adjustments in price and wage levels. When explained through an aggregate supply curve the supply curve shifts to the right side.

When wages decline the cost of production also declines and manufacturers produce goods at any given price which subsequently shifts the aggregate supply curve to the right, this shift in the supply curve makes the output to return to its normal rate.

4) A number macroeconomic variables decline during recessions. One of these variables is the GDP.

a) What other variables, besides real GDP, tend to decline during recessions? Given the definition of real GDP and its components, explain the declines in these economic variables which are to be expected.

Besides real GDP, investment spending is another variable that declines during recession as there is a general slowdown in the economy and unemployment rises as people stop consuming and stop buying products they don’t really need.

Consumption spending will also be another variable that will decline as people tend to buy only necessities and stop buying comfort and luxury goods.

b) Empirical studies indicate that the long-run trend in real GDP of the USA has an upward trend. How is this possible given business cycles and macroeconomic fluctuations? What factors explain the upward trend in spite of the cycles?

The long run trend in real GDP of the USA or any other country has an upward trend given its business cycles and macroeconomic fluctuation as the production of all the sectors are on the increase constantly. Given the rise in population the needs of the population must be met through increase in productive activities in all the sectors. This has resulted in the upward long run trend of the real GDP around the potential GDP trend line which is always upward sloping.

5) Assume there are short-run and long-run Macroeconomic Equilibriums in the economy.

Refer to the AS and AD curves above to answer the following questions.

What is the initial point of the long-run macroeconomic equilibrium? What are the equilibrium values? What does the appearance of the long-run aggregate-supply (LRAS) curve indicate? How does it differ from AS?

The initial point of the long-run equilibrium is where LRAS intersects with AD at point A. Values would be P1 and Y1. The LRAS indicates the real GDP is at its full potential and unemployment is at its natural level. LRAS differs from AS because AS moves into equilibrium with LRAS and AD. LRAS does not move due to change in price as does AS. When the economy reaches this long-run equilibrium, the expected price level will have adjusted to equal the actual price level. As a result, the short-run aggregate-supply curve crosses this point as well.

What are the factors that can shift short-run aggregate supply curve from AS1 to AS2?What does Point A represent in the graph? What does point B represent? Is it the short-run or long-run macroeconomic equilibrium? Explain.

Shifts in the AS curve can be caused by the following factors: changes in size & quality of the labor force available for production, changes in size & quality of capital stock through investment, technological progress and the impact of innovation ,changes in factor productivity of both labor and capital, changes in unit wage costs (wage costs per unit of output) ,changes in producer taxes and subsidies and ,changes in inflation expectations – a rise in inflation expectations is likely to boost wage levels and cause AS to shift inwards. Point A represents long run equilibrium because long-run equilibrium of the economy is found where the aggregate-demand curve crosses the long-run aggregate-supply curve Point B represents short-run equilibrium this is when the economy when the quantity demanded of Real GDP equals the(short-run) quantity supplied of Real GDP, where the aggregate demand curve intersects the short-run aggregate supply curve.

Assume aggregate demand (AD) is held constant, in the long-run, starting from point B, what will the economy likely experience? Will it reach the long equilibrium?

The economy would experience rising output and falling prices, the opposite of stagflation. It will not reach long equilibrium because Long-run equilibrium occurs at the intersection of the aggregate demand curve and the long-run aggregate supply curve.

Reference

Mankiw, N. G. (2015). Principles of Macroeconomics, 7th Edition. [Kaplan]. Retrieved from https://kaplan.vitalsource.com/#/books/9781305156067/https://kaplan.vitalsource.com/#/books/9781305156067/

Mankiw, N. G. (2015). Principles of Macroeconomics, 7th Edition. [Kaplan]. Retrieved from https://kaplan.vitalsource.com/#/books/9781305156067/https://kaplan.vitalsource.com/#/books/9781305156067/