The following graph shows the economy in long-run equilibrium at the expected pr
ID: 1193675 • Letter: T
Question
The following graph shows the economy in long-run equilibrium at the expected price level of 120 and the natural rate of output of $600 billion. Suppose firms become pessimistic about future business conditions and cut back on investment spending.
Shift the short-run aggregate supply (AS) curve or the short-run aggregate demand (AD) curve to show the short-run impact of the business pessimism.
In the short run, the decrease in investment spending associated with business pessimism causes the price level to-------------- the price level people expected and the quantity of output to ---------------- the natural rate of output. The business pessimism will cause the unemployment rate to------------ the natural rate of unemployment in the short run.
Again, the following graph shows the economy in long-run equilibrium at the expected price level of 120 and the natural rate of output of $600 billion, before the decrease in investment spending associated with business pessimism.
During the transition from the short run to the long run, price-level expectations will----------- and the short-run ------------ curve will shift to the ------------------------.
Now show the long-run impact of the business pessimism by shifting both the short-run aggregate demand (AD) curve and the short-run aggregate supply (AS) curve to the appropriate positions.
In the long run, as a result of the business pessimism, the price level --------------- , the quantity of output------------ the natural rate of output, and the unemployment rate---------------- the natural rate of unemployment.
Explanation / Answer
Shift the short-run aggregate supply (AS) curve or the short-run aggregate demand (AD) curve to show the short-run impact of the business pessimism.
In the short run, the decrease in investment spending associated with business pessimism causes the price level to FALL BELOW the price level people expected and the quantity of output to BE LESS THAN the natural rate of output. The business pessimism will cause the unemployment rate to BE HIGHER the natural rate of unemployment in the short run.
Again, the following graph shows the economy in long-run equilibrium at the expected price level of 120 and the natural rate of output of $600 billion, before the decrease in investment spending associated with business pessimism.
During the transition from the short run to the long run, price-level expectations will FALL and the short-run SUPPLY curve will shift to the RIGHT.
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