Question

3. Most global markets have been reporting severe contractions, which mainly responding to the COVID-19 pandemic. The situation is worsened by the decrease in people's confidence in the government as policymakers, spreading a wave of pessimism towards the future prospect of the economy. Explain how such wave of pessimism, ceteris paribus, may lead to short-term economic fluctuations, which will eventually work to push the economy back towards its long-run equilibrium. Use relevant diagrams to support your answer.

Answer 1

The global CVOID-19 problem has led to a decline in the aggregate demand, so now economy has slipped to lower output level equilibrium where the unemployment rate has increased substantially. The significant decline in the aggregate demand due to economic pessimism is making the recovery difficult to be dealt with.

Thus here the price and wage are down, thus in the short-run economy will remain underemployed. over the long run, the economy, the flexible price, and wage would shift the aggregate supply to right thereby leading to the full employment level.

following is the diagram:

Price Level LRAS Shon run equilibrium SRAS SARS1 AD AD 1 0 Y Real GDP

In this diagram, the fall in the AD would cause the recessionary gap, over the long run, the flexible price and wage would increase the output as the AS shifts to right. price declines and output rises here.