Question

Suppose that consumers become pessimistic about the future health of the economy. What will happen to aggregate demand and to output? Show this using AD/AS graphs. What might the president and Congress have to do to keep output stable?

Answer 1

Ans: As the onsumers become pessimistic about the future health of the economy, this will decrease the consumer confidence in the economy. They will spend less. As the aggregate spending in the economy decreases, the aggregate demand falls and AD curve shift to left. This is shown in the diagram given below. This would cause the price and output to decrease.

The government can use the expansionary fiscal policy in which it can raise government spending or reduces tax rates or uses a combination of both to increase the aggregate demand in the economy. On the other hand, the central bank can use expansionary monetary policy in which it can raise the money supply in the economy which will increase the aggregate demand in the economy. With the help of these policies, government will be able to increase the aggregate demand in the economy and economy returns back to its initital equilibrium level.