Question

An economy’s AD (Aggregate Demand) function is Y = 1000 – 2P and AS (Aggregate Supply)...

An economy’s AD (Aggregate Demand) function is Y = 1000 – 2P and AS (Aggregate Supply) function is P = 20 + 0.1Y. Show these two lines in a graph. Label graphs. Find the equilibrium price level (P) and GDP (Y) and show them on the graph.


Use the AS and AD curves to illustrate your points and discuss the effects of the following events on the price level and on the equilibrium GDP (Y) in the short run:
a) The labor unions negotiate with the government and succeed in increasing the minimum wage.
b) Consumer confidence drops due to an increase in gas-price.

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Answer #1

(1)

From AD function:

When Y = 0, P = 1000/2 = 500 (Vertical intercept) & when P = 0, Y = 1000 (Horizontal intercept).

From AS function:

When Y = 0, P = 20 (Vertical intercept).

In equilibrium, AD = AS.

1000 - 2P = 20 + 0.1Y

2.1Y = 980

Y = 466.67

P = 20 + 0.1 x 466.67 = 20 + 46.67 = 66.67

In following graph, AD & AS are the AD & AS curves intersecting at point E with price level P0 (=66.67) and real GDP Y0 (= 466.67).

NOTE: As per Answering Policy, 1st question is answered.

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