Determination relationship between real GDP and potential GDP.
Use an aggregate demand (AD) and aggregate supply (AS) model in which the short run aggregate supply curve slopes upwards to illustrate the equilibrium level of real GDP and prices if the economy is operating:
a. Graph three cases
b. In each case describe the relationship between real GDP and potential GDP.
c. If the economy were below full employment in the short run, would it adjust (self adjusting mechanism - no deliberate fiscal or monetary policy) to full employment and potential output over time?
d.Elucidate and illustrate the adjustment from short to long-run in (c) in your AD/AS diagram.
e. If the economy is not self-adjusting but a deliberate monetary policy is proposed to remove the output gap, how this process would be different than self-adjusting mechanism i.e. what curve or curves would shift and why? What would be after adjustment impact on the price level and output?