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  1. Consider an economy that is initially in long run equilibrium in the Aggregate Demand and Aggregate Supply (AD-AS) diagram that we covered in lectures. Suppose many Australian firms mistakenly expect that there will be an increase in the relative price of their own products as compared to others (including relative to the input costs and wages they pay). Start with the equilibrium point shown in the Figure below and use it to demonstrate the following changes.

  1. How does this change the aggregate price level, real income and unemployment in the short run? Explain and illustrate in the AD-AS diagram (3 marks)

Answer here (Tips: to create new lines, simply copy the existing curves and move to the new location)

  1. Explain the adjustment process to long run equilibrium (assuming that real potential output remains unchanged, so no change in LRAS), and what happens to the price level. No need to demonstrate it in Figure but it may be helpful. (3 marks)

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Consider an economy that is initially in long run equilibrium in the Aggregate Demand and Aggregate Supply (AD-AS) diagram that we covered in lectures. Suppose many Australian firms mistakenly expect that there will be an increase in the relative price of their own products as compared to others (including relative to the input costs and wages they pay). Start with the equilibrium point shown in the Figure below and use it to demonstrate the following changes. How does this change the aggregate price level, real income and unemployment in the short run? Explain and illustrate in the AD-AS diagram (3 marks) Answer here (Tips: to create new lines, simply copy the existing curves and move to the new location) LRAS0 P SRAS0 P0 Y YLR Explain the adjustment process to long run equilibrium (assuming that real potential output remains unchanged, so no change in LRAS), and what happens to the price level. No need to demonstrate it in Figure but it may be helpful. (3 marks) Some economists hold the views that Australia is heading to a recession (for such a view, read here HYPERLINK “http://www.abc.net.au/news/2016-07-29/australia-headed-for-recession-next-year,-professor-keen-says/7674154” http://www.abc.net.au/news/2016-07-29/australia-headed-for-recession-next-year,-professor-keen-says/7674154 One such scenario may come from a crash in the Australian housing market. Keeping in mind of the Aggregate Demand and Supply (AD-AS) framework, elaborate how such a shock may affect the Australian economy. Also, discuss what policy instruments the government have in response, and how they work in practice? The summary should be at least half a page in length (again, please do not write in the form of the bullet points). Showing the effects in AD-AS is not required. Attaching a list of references is preferred but not required. Please do not copy and paste from whatever you found on the web. We can easily detect this in our system! (4 marks) (Answer…

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