11. Applying the extended AD-AS model Aa Aa Financial crises, such as the one th

Question

11. Applying the extended AD-AS model Aa Aa Financial crises, such as the one that impacted many developed countries starting in 2007, decrease banks' ability and willingness to make loans. Decreased availability of credit decreases businesses' ability to make investment purchases and consumers' ability to buy goods and services. As a result, a financial crisis is a negative shock for an economy The following graph shows an economy's aggregate demand curve and its short-run and long-run aggregate supply curves after a financial crisis has pushed it into recession Suppose that the government decides not to use stabilization policy and allows the economy to adjust on its own Determine which curve, the aggregate demand curve or the short-run aggregate supply curve, shifts when the economy adjusts in the long run Use either the purple line (triangle symbols) to plot a new aggregate demand curve or the tan line (dash symbols) to plot a new short-run aggregate supply curve, to show the economy in long-run equilibrium. Make sure the curve you plot is parallel to one of the existing curves. (Note: You can check the slope of a line by hovering over it with your cursor.) AGGREGATE PRICE LEVEL 200 180 160 140 120 100 80 60 40 20 New AD LRAS SRAS New SRAS 2 46 8 10 12 14 16 18 20 REAL GDP (Trillions of dollarsl rlions of dollars) Help Clear All Clear ALL

Explanation / Answer

Since economy is below full employment,so it is a case of recession because output is below its potential level.

If employment is below natural level,real and nominal wage falls.Lower nominal wages reduces cost and hence short run aggregate supply curve shifts to right.

So nominal wage falls and SRAS shifts to right until economy is back to long run equilibrium.However it happens gradually.

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