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Hakan Yetkiner http://www.hakanyetkiner.com Izmir University of Economics Department of Economics ECON 202 MACROECONOMIC THEORY Dr. Yetkiner 25 April 2013 Key to Exercise 05 AD-AS Model 1. Suppose that the following information is given for an economy: ̅) ̅ ( )( ̅ (Short-run Aggregate Supply equation) (Long-run Aggregate Supply equation) (a) Find the AD equation. (b) Find the equilibrium and values. (c) Is this economy operating above or below potential GDP. (i) One needs to first determine IS and LM equations for AD equation. To this end, IS equation is: ( ( ( )( ) ) ) LM equation (for given P) is or . Notably, , , and are 3 unknowns in LM equation. If one uses IS equation in LM for eliminating , AD is obtained: ( ) Clearly, there is a negative relationship between (ii) Equilibrium values of unknowns in the model: 1 and . This is the AD equation. Hakan Yetkiner http://www.hakanyetkiner.com Izmir University of Economics Department of Economics ya da Since the second solution does not make sense, the answer must be the model can be found through substitution: ( ( ( . The rest of or ) ) )(( ) ( ( ) ) ( ) ) (iii) Since long run equilibrium is , short run equilibrium is lower than potential GDP. Hence, one must expect prices to decline, which causes a decline in real wages, among other effects. 2