Chapter 4R, Problem 1FRQ

a.

To determine

To draw: Labeled graph of aggregate demand and aggregate supply showing price and output equilibrium level.

Explanation of Solution

In the graph shown below, SRAS and LRAS represents the short-run aggregate and long run aggregate supply curve, P1 represents the price level whereas E represents at the Y1 output level:

  

Graph 1

Economics Concept Introduction

Supply and demand curve: Supply curve refers to the line that represents the relationship between the price of the product and the quantity that can be supplied by the producer. Demand curve refers to the relationship between price and the output at which consumers are ready to purchase.

b.

To determine

The impact of increased transfer payment along with the new equilibrium price level and new equilibrium output level.

Explanation of Solution

If government increased the transfer payment for the families with dependent children, then there will be overall increase in real GDP as price is increased to P2 with increased real GDP. This will result in new equilibrium represented by E2 at Y2.

  

Graph 2

Economics Concept Introduction

Supply and demand curve: Supply curve refers to the line that represents the relationship between the price of the product and the quantity that can be supplied by the producer. Demand curve refers to the relationship between price and the output at which consumers are ready to purchase.

c.

To determine

The new equilibrium in short-run along with the appropriate fiscal policy that can be beneficial for output gap issue.

Explanation of Solution

i)

An inflationary gap can be seen if new shore-run equilibrium resulted because as aggregate output increased from Y1 to Y2? and the aggregate price level increase from P1 to P2 and unemployment falls to a low level.

ii)

The fiscal policy that would be suitable for an economy that is going through an inflationary gap is contractionary type. As it will put equilibrium back to normal.

Economics Concept Introduction

Supply and demand curve: Supply curve refers to the line that represents the relationship between the price of the product and the quantity that can be supplied by the producer. Demand curve refers to the relationship between price and the output at which consumers are ready to purchase.