Question

Draw a graph to illustrate the wage and employment level adjusting to the demand shock.

Answer 1

positive AD SHOCK

equilibrium at point E, a positive demand shock would shift AD Curve from AD₁ to AD₂, rising both price and output level

in the short-run the economy moves to point N output is above the full employment level, Y_f.

firm compete to hire scare workers, driving up the wage rate. in the long run the higher the wage rate will shift the AS curve from SRAS₁ to SRAS₂

THE ECONOMY RETURN TO THE FULL LEVEL OF EMPLOYMENT AT POINT " L " IN LONG RUN

Negative AD SHOCK

Equilibrium at point L, a Negative demand shock would shift AD Curve from AD₁ to AD₂, falling both price and output level

in the short-run the economy moves to point N output is below the full employment level, Y_f.

With unemployed labor available, wages and unit costs will fall, causing firms to reduce their prices. AS curve will shift downward until full employment is regained from SRAS₁ to SRAS₂ with a lower price level in the long run

THE ECONOMY RETURN TO THE FULL LEVEL OF EMPLOYMENT AT POINT " E " IN LONG RUN