Problem 9 What is the difference in the lo... [FREE SOLUTION]

Chapter 14: Problem 9

What is the difference in the long run between a one-shot increase in aggregate demand and a one-shot decrease in short-run aggregate supply?

Short Answer

Expert verified

In the long run, a one-shot increase in aggregate demand increases the price level but retains the same level of real output after self-adjustment. Whereas a one-shot decrease in short-run aggregate supply leads to an increased price level and a decreased real output even in the long run.

Step by step solution

Analyze the impact of a one-shot increase in aggregate demand

When there's a one-shot, unexpected increase in aggregate demand, it shifts the AD curve to the right on an AD/SRAS/lRAS graph. During this shift, along the SRAS curve, the result is a higher price level and higher real output in the short run. Assuming that there's no change in aggregate supply, in the long run, the economy will self-adjust. SRAS curve will shift left to intersect with the long-run aggregate supply (LRAS) and the new AD curve, restoring the initial level of real output but with a higher price level.

Analyze the impact of a one-shot decrease in short-run aggregate supply

An unexpected one-time decrease in SRAS shifts the SRAS curve to the left. It leads to a decrease in real output and an increase in the price level. Even in the long run, as there's no self-adjusting mechanism to restore real output, it stays decreased, and the price level remains high, assuming constant AD.

Compare the impacts

The long-run difference between a one-shot increase in aggregate demand and a one-shot decrease in short-run aggregate supply is that, assuming AD and SRAS are the parameters changing, real output levels eventually restore to original with AD, while it decreases with a reduction in SRAS.