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Suppose that the aggregate demand curve in a particular year is given by the algebraic
expression: Y = 3000 + 1000/P, where Y is the aggregate output and P is the price level as given by the GDP Deflator. Potential GDP (Y*) = 4000.
a. Plot aggregate demand and long run aggregate supply curves. Show aggregate demand schedule.
b. Suppose that the prices are flexible. Determine the price level and show it on the graph.
c. Now suppose that the following year, the aggregate demand curve is given by:
Y = 3000 + 1100/P. In what direction has the aggragate demand curve shifted? If the aggregate output remains at the potential level, determine the new price level. Calculate the rate of inflation between the two years.
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