Unit 8 Assignment

Question:
1. Using aggregate demand, short-run aggregate supply, and long-run aggregate supply curves, explain the process and causes by which each of the following economic events will move the economy from one long-run macroeconomic equilibrium to another. In each case, explain the short-run and long-run effects on the aggregate price level and aggregate output.

a. There is a decrease in households’ wealth due to a decline in the stock market.
Point 1
Point 1
Point 3
Point 3

Point 2
Point 2

There is a decrease in a households wealth due to a decline in the stock market.
At point 1 the household consumption drops as wealth declines. This decreases spending at any price level and reduces the prices they are willing to pay. The falling price level and given wages raises the costs of hiring workers and output declines in equilibrium. This makes the equilibrium price and output drop to point 2. The falling price level combined with fixed wages will raise the relative or real wage as the economy goes into a recession. The relatively low demand for labor in the recession will put downward pressure on the nominal wage rate. The falling cost of production reduces the prices that firms demand for their production. Wages will fall until the labor market equilibrium return relative wages to their long-term levels. The new long run equilibrium will be at point 3.

Point 3
Point 3
Point 1
Point 1 Point 2
Point 2

b. The government lowers taxes, leaving households with more disposable income, with no corresponding reduction in government purchases.

When a household has more disposable income, they increase spending. This shifts out demand for goods and increases the prices they are willing to pay for goods. The higher prices of goods reduce the cost of labor. Falling real wages induce firms to increase production. The