Velocity is 5 Money supply is 120 Current price level is 6 Full employment level of output is 100 1a. Illustrate graphically the aggregate demand curve, the short run aggregate supply curve, and the long run aggregate supply curve. 1b. What is the long run aggregate price Level?
(1a) As per Classical quantity theory equation,
Money supply (M) x Velocity (V) = Price level (P) x Output (Y)
When economy is operating at full-employment level,
Long-run aggregate price level (P) = (M x V) / Y
= (120 x 5) / 100
Since Long-run aggregate price level is equal to Current price level (= 6), economy is currently in long run equilibrium. The aggregate demand (AD), long run aggregate supply (LRAS) and short run aggregate supply (SRAS) curves are depicted below, with long run equilibrium being at point A where AD, LRAS & SRAS intersect at real GDP (equal to Full employment or potential GDP) level of Y0 (= 100) and aggregate price level equal to P0 (= 6).
(1b) Long-run aggregate price level = 6
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