Question

2 - What is the short-term and long-term change to the long-run perfect competitive equilibrium as a result of a negative shock to demand side of market (left shift of demand). Explain graphically and in plain English what next is going to happen in this market.

Answer 1

Due to negative shift to demand curve, aggregate demand shift from AD to AD1 where price level fall from P to P1 and output level fall from Y to Y1 in short run.

In long run , producers will reduce their aggregate supply because of fall in demand in short run to avoid inventories which shift aggregate demand curve to its left from AS to AS1 which will raise price level to its initial point and reduce output level further to Y2.