Solving 2 Macro-economy Questions - Essay Example

In answering the first question, we need to define and understand the terms that are related with it. Aggregate supply is a schedule or curve that shows the total quantity of goods and services supplied or produced at different price levels (McConnell and Brue). In the long run, this aggregate supply is fully responsive to the changes in price level. Gross Domestic Product (GDP) is the primary measure of the performance of the economy as it measures the annual output of goods and services or the aggregate output.

The problem used two different types of GDP, the nominal GDP and real GDP. Nominal GDP is also called the unadjusted GDP because it is based on the prevailing prices when the output was produced. Real GDP is the adjusted GDP. It is called as such because it is the measure of the market value of all final output that is deflated or inflated to reflect the changes in the price level. In order to know the real GDP, a price index is used to adjust the GDP by dividing the nominal GDP with the price index.

When expressed in an equation, it is real GDP = nominal GDP/ GDP price index. The GDP price index is an index number showing how the weighted-average price of a “market basket” of goods changes over time. In our problem, the real GDP and price index were given and we are asked to compute for nominal GDP. For us to compute for the full employment level of nominal (GDP), we need to multiply the given real GDP ($1.2 trillion) by the price index of 115. This will give us the answer of $138 trillion as the full employment level of nominal GDP.

For question number 2, aggregate demand and the spending on purchases on goods and services are studied. Aggregate demand is the relationship between the quantity of output demanded and the aggregate price level (Mankiw). It tells us the quantity of good and services people will buy at any given price. An increase in the price level corresponds to a movement up along the unchanged aggregate demand curve. This means that a sudden rise in prices will cause the aggregate demand curve to move upward but unchanged.

At this higher price level, the consumption, investment, and net export components of aggregate demand will all fall; that is, there will be a reduction in the total quantity of goods and services demanded, but not a shift of the aggregate demand curve itself (www.web-books.com). The spending on peoples’ purchases on goods and services will be reduced causing the level of consumption to fall. We all know the basic principle about the negative relationship of price and demand. When the price is at low level, demand is higher but becomes lower when price is increased.

This explains why people are likely to buy less when prices are higher and tend to buy more when prices are low. So at times that there is a sudden rise in the price level, the aggregate demand will fall as consumers will cut on their spending. Bibliography Mankiw, N. Gregory. Macroeconomics. New York: Worth Publishers, 1997. McConnell, Campbell and Stanley Brue. Macroeconomics: Principles, Problems and Policies. New York: McGraw-Hill Companies, Inc. , 2005. www.web-books.com. "Aggregate Demand." n.d. www.web-books.com. 10 March 2011 .