Question

Price Level Aggregate Demand Short-Run Aggregate Supply 120 8,250 9,700 115 8,300 9,750 110 8,400 9,700 105 8,500 9,600 100 8,600 9,500 95 8,700 9,300 90 8,800 8,800 85 8,900 8,000 80 9,100 7,000

Return to the original values of aggregate demand and short-run aggregate supply. Assume potential GDP decreases to 7,000. Graph the aggregate demand curve, short-run aggregate supply, and the new potential GDP. Be sure to describe where the economy is operating in the short-run relative to where we want the economy to operate. Is the economy operating at full-employment? Is the unemployment rate greater or less than the natural rate of unemployment?

Answer 1

The economy is initially in equilibrium with aggregate demand curve AD₁ and Short Run Aggregate Supply Curve SRAS1 at its potential output Yp at a price level of P₁ . SRAS₂ shows reduced short run aggregate supply, which shows reduced price level P₂ and reduced Real GDP Y2. Now the economy shows a recessionary gap of Y₂ - Y_p.

with the real GDP below potential, price level falls and there will be unemployment.  

In this context, two realations should be remembered.

i) If Unemployemnt is greater than natural unemployment, real GDP will be less than Potential GDP

ii) If Unemployment is lower than natural unemployment, real GDP will be more than Potential GDP

In the given case, the first relation is applicable.