TutorialNotesCH9DetailedSolution
.pdf
School
Copenhagen Business School**We aren't endorsed by this school
Course
ECON 1220
Subject
Economics
Date
Dec 20, 2024
Pages
9
Uploaded by PresidentJaguarMaster971
ECON1220BCD Introductory MacroeconomicsChapter 9: AS-AD Model (Solution)YUNG Kai Chuen (Daniel)December 7, 2024Reference: Ch.13 Hubbard, R. G., Garnett, A. M., Lewis, P., & O’Brien, A. P. (2014). Macroeconomics.Question 7 and Question 8 is just for your reference, which are not covered in the examination.0.1Question 1How many statements for AS-AD properties are correct?1. SRAS could be either upward sloping or infinite slope.2. The slope of LRAS should be larger than 0.3. The intersection of the AD, SRAS and LRAS curves indicates a state where the economy is at its full em-ployment level of output with a stable price level.4. Change in Price level leads to shift in AD curve.5. LRAS could be expressed as the production function.Solution:Answer: 3 (2., 3., 5.)1. Incorrect: The Short-Run Aggregate Supply (SRAS) curve is typicallyupward sloping, indicating thatas prices increase, the quantity of goods and services supplied increases.2. Correct: The Long-Run Aggregate Supply (LRAS) curve isvertical, indicating that in the long run, thetotal output is determined by factors such as technology and resources, not by the price level. Slope isinfinite.3. Correct: This point represents the long-run equilibrium where the economy isproducing at its fullemployment level of output, and the price level is stable.4. Incorrect: A change in the price level results in amovementalong the Aggregate Demand (AD) curve,not a shift. Shifts in the AD curve are caused by changes in factors like consumer confidence, govern-ment policies, and foreign exchange rates.5. Correct: The LRAS can be represented by the production functionY=F·(K, L), which shows therelationship betweeninputs (like labor and capital) and the maximum outputthat can be producedwith those inputs.1
0.2Question 2How many statements are correct?1. Savings are essential for investments in capital goods2. Investments often involve adopting new technologies3. Investment projects boost savings and consumption.4. Investments generate returns, increasing income for individuals and the nation5. A high national savings rate cannot provide economic stabilitySolution:Answer: 3 (1., 2., 4.)1. Correct: Savings provide the funds necessary forinvestments in capital goods, which are crucial foreconomic growth.2. Correct: Many investments lead to theadoption of new technologies, which can enhance productivityand efficiency.3. Incorrect: While investment projects can boost consumption, they typicallyreduce savings in the shorttermas resources are allocated to the projects.4. Correct: Investments cangenerate returns, leading to higher incomes and economic growth.5. Incorrect: A high national savings rate canprovide economic stabilityby ensuring there are fundsavailable for investment and by buffering against economic shocks.0.3Question 31. How many factors would shift the aggregate demand curve (AD) curve to the right?(a) An increase in the money supply(b) An increase in household income(c) An increase in government spending(d) A rise in interest rates(e) A decrease in net exports2. Starting from a long-run equilibrium, use the basic Aggregate Demand (AD) and Aggregate Supply (AS)diagram to illustrate and explain the changes in both the long-run and short-run equilibria when there is adecline in wealth. You are recommended to make reference to above diagram.Solution:1.Answer: 3 (1.,2., 3.Page 2
(a) Correct: Increases in the money supplylowers the interest rate, which facilitates investment andshifts the AD curve to the right.(b) Correct: Higher (disposable) income generally leads toincreased in consumption, which shifts theAD curve to the right.(c) Correct: Increase in government spending directlyincreases aggregate demand, shifting the ADcurve to the right.(d) Incorrect: Higher interest rates usuallydiscourage borrowing and spending, which would shiftthe AD curve to the left.(e) Incorrect: A decrease in net exports meansfewer goods and services are being sold abroad, reduc-ing aggregate demand and shifting the AD curve to the left.2. The graph is put below.• Initial Equilibrium: The economy starts at pointCwith GDP atY1.• Negative Demand Shock in the Short Run: A decline in wealthshifts the aggregate demand curveleftwardfromAD1toAD2. Consequently, prices fall and output decreases. Unemployment risesas the economymoves below potential GDP(pointB).• Automatic Adjustment in the Long Run: The economic downturn leads workers and firms tolower their expectations about wages and prices. Over time, they accept lower wages and prices,shifting the short-run aggregate supply curve to the right. Eventually, the economy reaches pointA, with real GDP returning to potential GDP atY1and prices even lower. The unemployment ratereturns to its natural level.YPSRAS1AD2AD1SRAS2LRASSRE1SRE2LRE1LRE2Page 3
0.4Question 4How many combinations lead to the increase in real GDP and ambiguous price level in the short run?1. Increase in government purchasing + Increase in expected price of an important natural resources2. Increase in import + Increase in working age population3. Decrease in interest rate + Release consumption coupon4. Decrease in disposable income + Technological development5. Increase in net export + Increase in government spendingSolution:Answer: 0To achieve an increase in real GDP with an ambiguous impact on the price level, both aggregate demand andaggregate supply should shift to the right.1. Incorrect• Government purchasing increases Aggregate Demand (AD), shifting the AD curve to the right.• Increase in expected price of natural resources increases production costs, shifting the Short-RunAggregate Supply (SRAS) curve to the left.2. Incorrect• Increase in import shifts SRAS to the left because the wage of workers and firms increase. It shiftsAD to the right.• Increase in working age population shifts the labor supply to the right, boosting potential GDPand lowering production costs, which might lower price levels.3. Incorrect• Decrease in interest rate increases AD by making borrowing cheaper, shifting the AD curve to theright.• Release of consumption coupon further boosts AD by increasing consumer spending, shifting theAD curve to the right.4. Incorrect.• Decrease in disposable income taxes increases AD by boosting consumer spending, shifting theAD curve to the right.• Technological development increases SRAS by improving productivity, shifting the SRAS curve tothe right. Real GDP increases, and the price level is ambiguous because the rightward shifts in ADand SRAS can offset each other.5. Incorrect.• Increase in net export increases AD, shifting the AD curve to the right.• Increase in government spending also increases AD, shifting the AD curve further to the right.Page 4
0.5Question 5Please explaining the followings with the help of the diagram.1. From Section 2.2, 7 factors have been listed leading to shift of AD curve, please explaining each factorsrespectively.2. From Section 3.5, 5 factors have been listed leading to shift of SRAS curve, please explaining each factorsrespectively.Solution:1. Aggregate Demand• Increase in the interest rate: Increase the cost of borrowing, leading to reduced consumption andinvestment. This lowers aggregate demand.• Increase in Government Spending: Directly raises aggregate demand by increasing governmentconsumption of goods and services.• Increase in Taxes: Reduce disposable income for households and after-tax profits for businesses,which can lead to decreased consumption and investment, thus lowering aggregate demand.• Increase Households’ Expectations of Their Future Incomes: If households expect higher futureincomes, they are more likely to increase current consumption, raising aggregate demand.• Increase Firms’ Expectations of the Future Profitability of Investment Spending: If firms expecthigher future profitability, they are more likely to increase investment spending, which raises ag-gregate demand.• Higher Domestic Growth Rate relative Foreign Growth Rate: As incomes rise, consumers andbusinesses have more money to spend on goods and services, including those produced abroad.This increases the demand for imports. (Assume other factors remain the same)• Stronger Domestic Currency: Makes exports more expensive and imports cheaper, potentiallyreducing net exports and lowering aggregate demand.2. Aggregate Supply• The Labor Force or the Capital Stock: An increase in the labor force or capital stock leads to ahigher production capacity. This shifts the SRAS curve to the right, indicating that more goodsand services can be supplied at each price level.• Higher productivity: It means that firms can produce more output with the same amount of inputs.This also shifts the SRAS curve to the right, reflecting an increase in the overall supply of goodsand services.• Increase in Expected Future Price Level: Producer may hold back on current production to sell athigher prices later, potentially reducing current supply. This shifts the SRAS curve to the left.• Workers and Firms Adjusting to Previously Underestimated the Price Level: f workers and firmsrealize that they previously underestimated the price level, they may adjust wages and pricesupward, which shift the SRAS curve to the leftPage 5
• The Expected Price of Important Natural Resources: This higher cost of production shifts the SRAScurve to the left, indicating a reduction in the quantity of goods and services supplied at each pricelevel.0.6Question 6How many statements for automatic adjustment due to negative demand and supply shocks are correct?1. Skyrocketing oil prices are considered as part of the negative supply shock2. Rise in oil price are considered as part of the positive demand shock3. With the economy producing below the potential (Y <¯Y), more people are unemployed (u > NAIRU) inboth negative demand and supply shocks4. The unemployment rate in LRAS is the sum of frictional unemployment, search unemployment and cyclicalunemployment5. At the short-run equilibrium:˜Yt=Yt−¯Yt¯Yt<0Solution:Answer: 1., 3., 5.1. Correct. Skyrocketing oil prices increase production costs for many goods and services, leading to anegative supply shock.2. Incorrect. A rise in oil prices is typically a negative supply shock, as it raises production costs ratherthan increasing demand.3. Correct. When the economy is producing below potential output, unemployment rates are generallyhigher than the natural rate of unemployment in both negative demand and supply shocks.4. Incorrect. The unemployment rate in the long-run aggregate supply (LRAS) only includes frictionaland structural unemployment, but not cyclical unemployment, which is associated with short-termeconomic fluctuations.5. Correct. In the short-run equilibrium, if actual outputYtis less than potential output¯Yt, then˜Yt, whichis the output gap, will be negative.0.7Question 7Chief Executive John Lee has been advocating for the development of the technological industry. Several mea-sures have been implemented, such as providing more incentives for mainland firms to establish their head officesin Hong Kong and increasing funding for STEM development. These measures are part of a broader strategy totransform Hong Kong into an international innovation and technology hub.1. Define what is the difference between permanent technological development and technological develop-ment with the aid of the AS-AD graph.2. Give some criteria that these measures are considered as permanent technological development.Page 6
3. Given that the production are as follows:Y=A·K23L13Please calculate the Real GDP when K is 50, L is 100 and technological factor is 10, the CPI is 100 using 2024as the based year.4. After the implementation of the policy, government economists forecast the K decreases to 40, L decreasesto 80, technological factor increases to 20, the GDP deflator is 98.33 using 2024 as the based year. Calculatethe real GDP again.5. Does the result align with the theory of permanent technological advancement? If so, could you providethe formula for Aggregate Demand (AD).Solution:1. Permanent technological development refers to long-term improvements in technology that shift boththe Aggregate Supply (AS) and Long-Run Aggregate Supply (LRAS) curves to the right, reflecting apermanent increase in the economy’s productive capacity. In contrast, temporary technological devel-opment primarily affects the Short-Run Aggregate Supply (SRAS) curve, shifting it to the right withoutnecessarily affecting the LRAS curve.2. For the measures to be considered as permanent technological development, they should:• Lead to sustained increases in productivity.• Result in long-term improvements in infrastructure and human capital.• Foster an environment that supports ongoing innovation and technological advancements.• Create systemic changes that enhance the economy’s productive capacity.3. Given the production function:Y=A·K23·L13Initial Conditions:K= 50,L= 100,A= 10, and CPI (base year 2024) = 100. Calculate nominal GDP:Y= 10·5023·10013Breaking it down:K23= 5023≈15.8745L13= 10013≈4.6416Hence:Y= 10·15.8745·4.6416≈736.22Since CPI = 100 (base year), the real GDP = nominal GDP in the base year:Real GDP= 736.224. New Conditions:K= 40,L= 80,A= 20, GDP deflator = 98.33. Calculate new nominal GDP:Y= 20·4023·8013Page 7
Breaking it down:K23= 4023≈13.1447L13= 8013≈4.3089So:Y= 20·13.1447·4.3089≈1133.77To get the real GDP:Real GDP=Nominal GDPGDP Deflator×100Real GDP=1133.7798.33×100≈1153.135. The increase in the technological factor from 10 to 20 significantly boosts productivity, even with areduction in capital and labor inputs, resulting in a higher real GDP. This aligns with the theory ofpermanent technological advancement, where improvements in technology lead to sustained increasesin productivity and economic0.8Question 8Census and Statistic Department has released the recent statistics. They have discovered the followings:• Total consumption has increased from 530 billion to 550 billion• Total export has reduced from 70 billion to 60 billion• Other GDP components, such as investment, government spending and import remains the same.• The labor force participation rate accounts for 80% of total working age population, whereas working agepopulation is 4,000,000, in which the working age population is 3,600,000 but the labor participate rate is90% before.• Discouraged workers increase from 50,000 to 62,000 because of the lower upward mobility.Given that all the GDP components are used in therealterms.1. Please explaining the above phenomena with the help of AS-AD graph.2. There are some contradictory results in the AS-AD graph. Can you compare those effects each other.3. Can you provide some implementations leading to shift in both SRAS and LRAS.Solution:1. Explanation with AS-AD graph•Increase in Total Consumption: The rise in total consumption from 530 billion to 550 billion shiftsthe AD curve to the right (AD1 to AD2), indicating an increase in aggregate demand.•Decrease in Total Export: The reduction in total export from 70 billion to 60 billion shifts the ADcurve to the left (AD2 to AD3), partially offsetting the increase in consumption. The net effect willdepend on the relative sizes of these changes.Page 8
•Labor Force Participation: The labor force participation rate has decreased from 90% of 3,600,000to 80% of 4,000,000. This change may affect the long-run aggregate supply (LRAS) curve due to apotential reduction in labor supply.•Increase in Discouraged Workers: The number of discouraged workers has increased from 50,000to 62,000, indicating rising unemployment. This increase reflects a reduction in the active laborforce, which may further impact the LRAS curve.2. Contradictory Results in the AS-AD•Rightward Shift in AD due to Higher Consumption: The increase in consumption shifts the ADcurve rightward, leading to higher aggregate output and price levels in the short run.•Leftward Shift in AD due to Lower Exports: The decrease in exports shifts the AD curve leftward,counteracting the increase from higher consumption. The net effect on the AD curve will dependon the magnitudes of these changes.• Since increase quantity of consumption is larger than decrease in export, AD graph shifts to theright.3. To shift both the Short-Run Aggregate Supply (SRAS) and Long-Run Aggregate Supply (LRAS) curvesrightward, the following measures can be implemented:•Enhancing Labor Force Participation: Policies aimed at increasing labor force participation, suchas job training programs, childcare support, and incentives for older workers to remain in theworkforce, can increase the labor supply and shift both SRAS and LRAS to the right.•Investing in Technology and Infrastructure: Increasing funding for technological developmentand infrastructure projects can improve productivity, leading to a rightward shift in both SRASand LRAS.•Educational and Skills Development: Investing in education and skills development can enhancehuman capital, increasing the productivity of the workforce and shifting both SRAS and LRASrightward.•Encouraging Research and Development (R&D): Providing incentives for R&D can foster inno-vation, leading to technological advancements that enhance productivity and shift both SRAS andLRAS to the right.•Improving Business Environment: Streamlining regulations, reducing bureaucratic barriers, andproviding tax incentives for businesses can encourage investment and expansion, shifting bothSRAS and LRAS to the right.Page 9