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Economics (MindTap Course List)

13th Edition
Roger A. Arnold
ISBN: 9781337617383

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BuyFindarrow_forward

Economics (MindTap Course List)

13th Edition
Roger A. Arnold
ISBN: 9781337617383
Textbook Problem

Illustrate graphically what would happen in the short run and in the long run to the price level and Real GDP level if individuals hold rational expectations, prices and wages are flexible, and individuals underestimate the decrease in aggregate demand (bias downward).

To determine

The short-run and long-run effects of price and real GDP.

Explanation

In Figure 1, the real GDP is measured on the horizontal axis and the price level is measured on the vertical axis. Point 1 shows the initial level of equilibrium where the expected price level equals the actual price level. Then, there is a decrease in the aggregate demand from AD to AD2. If people underestimate the decrease, then their expected price falls to P2, which is higher than the actual price...

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