Question

1. Explain how consumer pessimism (or loss of consumer confidence) may affect AD and the macro equilibrium viz., the equilibrium value of each of the macro variables in the tables below, in both the long and short runs.
2. Apparently both investor pessimism and consumer pessimism would affect the macro- economy via a reduction in aggregate demand. Explain whether and why
(a) there are any difference at all in their effects on prices and quantities in the various (incl. labor, capital-input, goods, loanable-funds, and money) markets; and
(b) there are any differences at all in their policy implications i.e., stabilisation (fiscal and monetary) policies that are required to close output gaps created by these 2 alternative types of pessimism.

Answer 1

1.

When consumer pessimism takes place, then aggregate demand in the economy decreases. It makes AD curve to shift to the left and a new short run equilibrium is established.. As a result, it leads to decrease in the real GDP, decrease in the price level and increase in the unemployment in the short run. Due to these changes in the macro variables such as real output, unemployment level and price level, the cost of production also decreases as people now opt for the jobs at lower wages as well. It leads to supply curve to shift to the right and it achieves a long run equilibrium. So, in the long run, price level decreases. Further, unemployment level reaches to the natural rate of unemployment and real output goes to the level of potential output in the long run.

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