The following graph shows the economy in long-run equilibrium at the expected price level of 120 and the natural level of output of $600 billion. Suppose firms become pessimistic about future business conditions and cut back on investment spending. Shift the short-run aggregate supply (AS) curve or the aggregate demand (AD) curve to show the short-run impact of the business pessimism. ADAS02004006008001000120024020016012080400PRICE LEVELOUTPUT (Billions of dollars)AD1 AD2 AS In the short run, the decrease in investment spending associated with business pessimism causes the price level torise above the price level people expected and the quantity of output torise above the natural level of output. The business pessimism will cause the unemployment rate tofall below the natural rate of unemployment in the short run. Again, the following graph shows the economy in long-run equilibrium at the expected price level of 120 and the natural level of output of $600 billion, before the decrease in investment spending associated with business pessimism. During the transition from the short run to the long run, price-level expectations willadjust downward and theaggregate demand curve will shift to theright . Now show the long-run impact of the business pessimism by shifting both the aggregate demand (AD) curve and the short-run aggregate supply (AS) curve to the appropriate positions. ADAS02004006008001000120024020016012080400PRICE LEVELOUTPUT (Billions of dollars)AD1 AD2 AS1 AS2 In the long run, as a result of the business pessimism, the price levelincreases , the quantity of outputreturns to the natural level of output, and the unemployment ratereturns to the natural rate of unemployment.

Economics: Private and Public Choice (MindTap Course List)

16th Edition

ISBN:9781305506725

Author:James D. Gwartney, Richard L. Stroup, Russell S. Sobel, David A. Macpherson

Publisher:James D. Gwartney, Richard L. Stroup, Russell S. Sobel, David A. Macpherson

Chapter10: Dynamic Change, Economic Fluctuations, And The Ad-as Model

Section: Chapter Questions

Problem 12CQ

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Economic fluctuations I

The following graph shows the economy in long-run equilibrium at the expected price level of 120 and the natural level of output of $600 billion. Suppose firms become pessimistic about future business conditions and cut back on investment spending.

Shift the short-run aggregate supply (AS) curve or the aggregate demand (AD) curve to show the short-run impact of the business pessimism.

ADAS02004006008001000120024020016012080400PRICE LEVELOUTPUT (Billions of dollars)AD1 AD2 AS

In the short run, the decrease in investment spending associated with business pessimism causes the price level torise above the price level people expected and the quantity of output torise above the natural level of output. The business pessimism will cause the unemployment rate tofall below the natural rate of unemployment in the short run.

Again, the following graph shows the economy in long-run equilibrium at the expected price level of 120 and the natural level of output of $600 billion, before the decrease in investment spending associated with business pessimism.

During the transition from the short run to the long run, price-level expectations willadjust downward and theaggregate demand curve will shift to theright .

Now show the long-run impact of the business pessimism by shifting both the aggregate demand (AD) curve and the short-run aggregate supply (AS) curve to the appropriate positions.

ADAS02004006008001000120024020016012080400PRICE LEVELOUTPUT (Billions of dollars)AD1 AD2 AS1 AS2

In the long run, as a result of the business pessimism, the price levelincreases , the quantity of outputreturns to the natural level of output, and the unemployment ratereturns to the natural rate of unemployment.

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