Question

The graphs illustrate an initial equilibrium for the economy. Suppose that the stock market broadly decreases. Use the graphs to show the new positions of aggregate demand (AD), short-run aggregate supply (SRAS), and long-run aggregate supply (LRAS) in both the short run and the long run, as well as the short-run and long-run equilibriums resulting from this change. Then, indicate what happens to the price level and GDP in the short run and in the long run. Short-run graph Long-run graph LRAS LRAS SRAS Short-run equilibrium Long-run equilibrium Aggregate price level Aggregate price level Real GDP Real GDP

Answer 1

Short-run graph Long-run graph LRAS LRAS SRAS SRAS SRAS Long-run equilibriupf Short-run cquilibrium A AD AD AD AD' Real GDP Real GDP In the long run, the price level In the short run, the price level and and GDP GDP rana aaud aa38y Aggregate price level

A decline in the stock market will reduce investment expenditure in the economy and thus shift the AD curve leftwards to AD' and new short run equilibrium occurs at point B where both the price level and national and output has fallen in the economy. In the long run, this leads to increase in unemployment rate and thus wage rate will decline as bargaining power of workers will decline and this reduces cost of production and shifts the SRAS curve rightwards to SRAS' and new equilibrium occurs at point C where prices have fallen and output has returned to its potential level.

Thus, in the short run, the price level reduces and GDP also decreases.

In the long run, price level has reduces and GDP has returned to its potential level.