This question is based on Fiscal Policy Analysis.
1. The short-run equilibrium price level and output are PL² and Y¹, where Equilibrium Price is PL₂ and Equilibrium Output is Y¹.
<h3>What is Fiscal Policy?</h3>Fiscal policy is defined as the use of government spending and tax policies to regulate and control the economic situation of a country. The conditions controlled in this case are macro-economic indices such as inflation, unemployment, equilibrium wage levels, etc.
2. If the Short-Run Equilibrium price level falls, the new equilibrium price level will become PL¹. This is because the next lowest price level below PL² is PL¹.
3. If Investment (or spending or demand) is increased in the short run, the equilibrium price level will sit at PL³.
4. After a negative supply shock (that is supplies took a negative turn), the new short-run equilibrium price will be fixed at PL¹ with Y being equal to Y¹.
5. If the real GDP was Y³ the type of Unemployment that could result are:
- Demand Deficient Unemployment and
- Voluntary Unemployment.
Demand Deficient Unemployment occurs because the company no longer has sufficient demand for its products to sustain its operations. This leads to the company reducing production as well as its workforce. Notice the huge huge unmet demand as depicted in points PL²Y², PL³Y³, and PL₁Y¹ (See attached image for the shaded region).
Voluntary Unemployment is similar to demand deficient Unemployment. The causes are the same. The difference here is that the employees voluntarily resign because it is no longer financially rewarding. This may be due to huge pay reductions as a result of low demand oversupply.
6. Where the GDP or output was Y², the type of unemployment that would exist is called Natural unemployment. Note that Y² is the equilibrium output point.
Natural unemployment is the difference between those who want to do a job at the present wage rate and those who do not want to due to personal choices or the ability to do so.
7. The long-run equilibrium price (LRAS) where the ages and resources are flexible will be PL¹, PL², PL³, and PL⁴. This is because, in the long run, the economy can create natural levels of employment and potential output at any given price level.
8. Based on the question and the information provided by the graph, the long-run equilibrium output will stand at Y⁴ if government spending increases.
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