1. Equilibrium: Real Output (GDP) & the Price Level Unit 3 Part 5 Krugman Section 4 Module 19

2. Review Equilibrium PL and Y are found where the AD and AS curves intersect. Equilibrium PL and Y are found where the AD and AS curves intersect. See skeleton graph See skeleton graph

3. Decreases in AD If AD decreases, recession and cyclical unemployment may result (prices don’t fall easily) If AD decreases, recession and cyclical unemployment may result (prices don’t fall easily) –1. wage contracts are not flexible (or sticky) so businesses cannot afford to reduce prices –2. employers are reluctant to cut wages because of impact of employee effort –3. fear of price wars keep prices from being reduced also

4. Shifting AS Leftward shift in the curve illustrates cost- push inflation Leftward shift in the curve illustrates cost- push inflation Rightward shift in curve will cause a decline in price level Rightward shift in curve will cause a decline in price level

5. Manipulating the AS and AD model Read each scenario. Draw a correctly labeled AD and AS graph to illustrate each short-run impact. You do not need to graph the LRAS at this point. Read each scenario. Draw a correctly labeled AD and AS graph to illustrate each short-run impact. You do not need to graph the LRAS at this point. During a long, slow recovery from a recession, consumers postponed major purchases. Suddenly they begin to buy cars, refrigerators and furnaces to replace their failing models. During a long, slow recovery from a recession, consumers postponed major purchases. Suddenly they begin to buy cars, refrigerators and furnaces to replace their failing models.

6. PL Real GDP SRAS AD AD2 AD will increase as a result of increased consumer spending PL1 Y1 PL2 Y2

7. With no other dramatic changes, the government raises taxes & reduces transfer payments in the hope of balancing the federal budget. With no other dramatic changes, the government raises taxes & reduces transfer payments in the hope of balancing the federal budget. PL Real GDP SRAS AD AD2 Higher taxes and a reduction in transfer payments reduce DI, which reduces consumer spending. PL2 Y2 PL1 Y1

8. Because of rising tensions in many developing countries, firms begin to build new factories in Econoland. Because of rising tensions in many developing countries, firms begin to build new factories in Econoland. PL GDPr AD SRAS AD2 The increase in investment spending will increase AD. P1 Y1 Y2 P2

9. Econoland’s factories have to pay for pollution clean up. PL GDP PL1 Y1 SRAS AD SRAS2 PL2 Y2 SRAS to the left due to gov’t regulation of pollution clean up— Input price

10. News of possible future layoffs frightens the public into reducing spending and increasing saving for the feared “rainy day.” News of possible future layoffs frightens the public into reducing spending and increasing saving for the feared “rainy day.” PL GDPr SRAS AD AD2 A decrease in consumer confidence decreases consumption spending. PL1 Y1 PL2 Y2

11. Brazil solves its foreign debt and inflation problems. It then orders $10 billion worth of capital machinery from Econoland. Draw the AD and SRAS graph for Econoland. Brazil solves its foreign debt and inflation problems. It then orders $10 billion worth of capital machinery from Econoland. Draw the AD and SRAS graph for Econoland. PL GDPr AD SRAS AD2 Econoland’s exports increase. AD increases. PL1 Y1 PL2 Y2

12. OPEC decided to lower the price of oil. PL GDP PL1 Y1 SRAS AD SRAS2 PL2 Y2 SRAS to the right due to cheaper input prices