eco 192 chapter 33 study guide/problem set (Part B):

AD/AS analytical framework

İAÜ Spring term 2022

Associate Professor (Doçent Dr) Salvatore Joseph Terregrossa, PhD

Using information from the online PowerPoint 8 presentation, the PowerPoint 8

presentation lecture notes, and/or the text book, answer the following questions, and give
clear, concise explanations:

Question 1:
Construct a diagram with the average price level (P), as represented by the
consumer price index (CPI), measured on the vertical axis; and the level of
real GDP (Y), as represented by the amount of final goods and services
produced within the nation, measured on the horizontal axis. Draw the
downward sloping aggregate demand (AD) function, the vertical long-term
aggregate supply function (LRAS), and the upward sloping short-term
aggregate supply function (SRAS), with all three functions intersecting at a
common point; thus representing both long-run and short-run equlibrium
simultaneously.
Suppose that there is a wide loss of confidence in the economy by firms;
and that this leads to a large decrease in quantity supplied of goods and
services at a given average price level (P). In other words, there is an inward
shift in the upward-sloping short-run AS function.
a) Draw this inward shift in SRAS on the diagram.
b) Identify the new short-run equilibrium.
c) Explain how consumers may react to the inward shift in SRAS.
d) Explain how the economy may self correct on its own, and return
to the long run equilibrium at the natural rate level of real GDP.
e) Show this adjustment on the diagram.
f) Explain the benefit of the self-correcting process.
g) Explain the cost (or problem) of this approach by policy makers.
Question 2:
Construct another diagram with the downward sloping aggregate demand
(AD) function, the vertical long-term aggregate supply function (LRAS), and
the upward sloping short-term aggregate supply function (SRAS), with all
three functions intersecting at a common point; thus representing both
long-run and short-run equlibrium simultaneously.
Again, suppose that there is a wide loss of confidence in the economy by
firms; and that this leads to a large decrease in quantity supplied of goods
and services at a given average price level (P). In other words, there is an
inward shift in the upward-sloping short-run AS function.
a) Draw this inward shift in SR AS on the diagram.
b) Identify the new short-run equilibrium.
c) Explain how expansionary fiscal and/or monetary policies may
return the economy to the long-run equilibrium at the natural rate
level of real GDP.
d) Show this adjustment on the diagram.
e) Explain the benefit of this approach by policy makers.
f) Explain the cost (or problem) of this approach by policy makers.

Question 3:
a) Summarize the pros and cons (positives and negatives) of implementing
expansionary fiscal and/or monetary policies to return the economy to
the long-run equilibrium at the natural rate level of real GDP; rather than
rely on a strategy of allowing the economy to self-correct on its own.

b) Summarize the pros and cons (positives and negatives) of a strategy of

allowing the economy to self-correct on its own; rather than
implementing expansionary fiscal and/or monetary policies to return the
economy to the long-run equilibrium at the natural rate level of real
GDP.