Topic 1

1. Discuss the importance AS-AD model in explaining the macroeconomic conditions of the economy and business cycles like recessions.

During a recession, the economy experiences a decline in real GDP (Mankiw, 2012). In the short-run, a decline in investment shifts the aggregate demand to the left causing a fall in price and output. Therefore, from the aggregate demand and supply model, the action will create a recession. Similarly, firms and workers will try to adjust to the price that is lower than what was expected. The costs of production will fall causing the short-run aggregate supply to shift to the right or increase.

1. What factors shift AS and AD curves? How do you explain macroeconomic fluctuations using AS-AD model and AS/AD curves?

A shift in aggregate supply curve is caused by changes in input prices, the productivity of resources and the legal-institutional environment. Also, a shift in the aggregate demand curve in caused by changes in consumer spending, investment spending, government purchases, net export, money supply, taxes and savings.

Economic fluctuations are caused by a shift in aggregate demand and aggregate supply curves. When aggregate demand decreases in the short-run, output and price level decrease (Mankiw, 2012). Over time, the change in expectation leads to adjustments to wages, prices and people’s perceptions and the SRAS curve will shift to the right. The economy will return to its natural rates of output and unemployment in the long-run, but the price will be lower. On the other hand, stagflation results from a fall in aggregate supply. Over time, prices, wages and perception will adjust, and the economy recovers.

Topic 2

1. What are the long-run macroeconomic goals? What is long-run macroeconomic equilibrium? How the goals are relate to the macroeconomic equilibrium?

The long-run macroeconomic goals are to attain full employment, stable prices, steady growth and stable interest rates (Mankiw, 2012). The long-run macroeconomic equilibrium occurs when real GDP equals potential GDP. At this point, the economy is on its vertical long-run supply curve.

In the long-run, the economy is at full employment and the prices of goods and services depends only on the circulation of money in the system. Therefore, the central bank will control the money supply by regulating interest rates to maintain price stability. Price stability and full employment will result in a steady economic growth.

1. Suppose that consumers and investors become pessimistic about the future health of the economy. What will happen to aggregate demand and to output?

As consumers become pessimistic about the future health of the economy, they will cut their spending; hence the aggregate demand will shift to the left and output will reduce.

Reference

Mankiw, N. G. (2012). Principles of macroeconomics. Mason, OH: South-Western Cengage Learning.

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