Please don\'t just copy another answer The AD/AS model is useful in predicting t
ID: 1226328 • Letter: P
Question
Please don't just copy another answer
The AD/AS model is useful in predicting the effects of various shocks and policy changes on an economy. The model is based on goods and services being exchanged in wellfunctioning markets. In general, however, markets are not always perfect. Consider how the model would change as a result of market imperfections. (Hint: Can the AS/LRAS shift when there are governmental controls?)
How would the AD/AS model change if input prices, such as wages and raw material prices, were set by the government rather than in markets?
If the government sets input prices, what long-run effect would this have?
Explanation / Answer
1) if input prices, such as wages and raw material prices, were set by the government rather than in markets then it will affect aggregate supply in the economy. If the input prices set by the government are high then the cost of production in the economy increases and accordingly, aggregate supply in the economy decreases. If the input prices set by the government are low then the cost of production in the economy decreases and accordingly, aggregate supply in the economy increases.
Thus, the input prices, such as wages and raw material prices, set by the government may cause aggragate supply to fall or rise in the economy depending on whether input prices set by government are high or low.
2) If the government sets input prices, the long-run effect of this would be on the level of output in the economy. In long run, all factors of prodution (Land, Labor, Capital etc.) become variable; no factor remains fixed. In this period, production in the economy can be increased by keeping the prices of factors of production at restricted level i.e., prices of factors of production should not be very high. Accordingly, if the input prices set by the government in long-run are less / low then the aggregate supply can be increased in the economy easily. Thus, the level of output in the economy will also increase by keeping prices of inputs at low level.