(A) Using a CLG of AD/AS, show the current equilibrium RGDP, labelled Yc, and PL in Southland, labelled PLc.
Understand that the phrase unemployment is greater than the natural rate of unemployment is code for recession.
I always start my AD/AS curves from Equilibrium and then draw in the effect of what's going on in the question.
Example:
Show means to draw & label graph correctly, use arrows showing effect & describe with correct terminology what is happening.
The President of Southland is receiving advice from two advisors. Kohl's and Raymond - about how best to reduce unemployment.
(B) Kohelis advises the president to decrease personal taxes.
(i) How would such a decrease in taxes affect aggregate demand? Explain.
A decrease in taxes is an expansionary policy action, like if the government had increased spending. So, a decrease in personal taxes increases the disposable income in people's pockets and therefore they will spend more, increasing (C) consumption and AD will increase. AD increasing will push increase output and more people will go back to work.
From the Fiscal Policy Cheat cheat sheet here.
(ii) Using a CLG of the SRPC (short-run phillips curve), show the effects of a decrease in taxes. Label the initial equilibrium as (A) and the new equilibrium from the decrease in taxes as point B.
Phillips Curve cheat sheet is here.
Check yourself
If the PL increases and unemployment has decreased on your Phillips curve, your AD/AS curve after the personal tax decrease should have the same effects.
(C) Raymond advises the President to take no action.
(i) What will happen to the SRAS curve in the Long-Run? Explain.
Understand that "take no policy action" is code for "in the long run".
So, if there is a recession and the government does nothing, two things will happen.
1) Prices will fall - which will stimulate quantity demand
2) Wages will fall - unemployed will accept lower wages - employers will hire more people as wages fall
Wages is an input cost (resource cost) - it also is a determinate of supply. If wages for a firm fall then the supply curve shifts rightward and more output is produced. If the wages in all of society fall, then the SRAS curve shifts rightward and output/RGDP increases. If output increases then unemployment falls.
(ii) Using a CLG of the SRPC (short-run phillips curve), show the effects of a change in the short-run aggregate supply you identified in part (c)(i).
Understand that if AD shifts on the AD/AS curve it is a movement on the Phillips Curve, but if AS shifts it is a shift of the Phillips Curve.
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| PL decrease Unemployment decreased |
So, What would the AD/AS curve look like for Recession "In the long-run"
From the Phillips Curve Cheat Sheet here.
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