Question

1. Consider the aggregate demand – aggregate supply (AD-AS) model. Assume the economy is initially at its long-run equilibrium.
   1. Produce a new graph, draw the aggregated demand curve, short-run aggregate supply curve, and the long-run aggregate supply curve and label the curves. Label both the horizonal and vertical axes clearly. Label the long-run equilibrium as A and its corresponding output level as Y1
   2. Now assume a positive supply shock hits the economy. In the graph, show the short-run effects of this positive supply shock. Label the new short-run equilibrium as B and its corresponding output as Y2
   3. In the same graph, show how the economy adjusts after the shock hits. After the economy fully adjusts, label the new short-run equilibrium as C and its corresponding output as Y3

Answer 1

Ans)

When there is positive supply shock, aggregate supply curve will shift to the right. If price level do not adjust, there will be surplus in the economy.

Slowly, when the price level starts adjusting, new short run equilibrium will be established at price level lower than the original price level.

(Here P on graph is Price level).