1. Drag the AD and AS curves back and forth as far as you can and make note of the differences in real GDP (Q) and the general price level which result from (1) a `policy adjustment` to the change and (2) a `self correcting equilibrium` resulting from the change by clicking those buttons after each of your moves.

When AS curve shifts left and policy adjustments are added, the GDP is restored at the expense of higher price. When AS curve shifts right which increases GDP but at higher prices, policy adjustments can be used to lower prices and GDP is restored. When AD curve is shifted left or right and policy adjustments are added, the price and GDP returns to original price.

Figure 1. AD Shifts Left (Self Correcting) Figure 2. AD Shifts Right(Self Correcting)

When AD curve shifts left, the equilibrium price will be lower in the long run as the GDP is restored. When AD curve shifts right, the equilibrium price will go up in the long run as GDP is restored. When AS curve is shifted left or right, the long run effect would restore equilibrium price goes back to the original price and original GDP. Thus without economic policy, the long run self correcting effects will tend to restore GDP and prices when supply changes.

Figure 1. AS Shifts Left (Policy Adjustment) Figure 2. AS Shifts Right(Policy Adjustment)

2. For Chapter 16 Interactive Graphing compare and contrast results of changing Aggregate Demand and Aggregate Supply on Prices and GDP (Q) using “policy adjustment” versus “self correcting equilibrium.”

Policy adjustment alone can restore original prices and GDP when AS curve changes while the self correcting equilibrium in the long run which tends to restore GDP could result in higher or lower price depending on the AD shift. If AD curve shifts, the self correcting equilibrium which tends to restore GDP will restore prices in the long run but policy adjustment can be used to lower or raise prices. The two are important factors to control GDP and prices.

3. Who is the economist who invented the `equation of exchange`?

Irving Fisher (1867-1947) developed the equation of exchange

4. Define the “equation of exchange.”

MV + M’V’ = PT

where

(M) is currency

(V) is velocity

(M’) is the checkable deposits

(V’) is the velocity of checkable deposits

(P) is price level

(T) is trade

References

C. MacConnell, S. Brue (2005). Economics: Principles, Problems, and Policies, 16/e. Graphing Exercise: Extended AD/AS (Chapter 16.1). Retrieved February 16, 2007 from http://highered.mcgraw-hill.com/sites/0072819359/student_view0/chapter16/interactive_graphs.html

C. MacConnell, S. Brue (2005). Economics: Principles, Problems, and Policies, 16/e. Equation of Exchange (Chapter 19.2). Retrieved February 16, 2007 from http://highered.mcgraw-hill.com/sites/0072819359/student_view0/chapter19/origin_of_the_idea.html#1