Question

Show a complete graph for both of these shocks. You will need two graphs only, one for each shock. The graphs have to show:

-The new short run equilibrium immediately after the shock occurs.

-The new long run equilibrium.

-The transition to the long run equilibrium.

Properly label your axes and the curves in your graphs, and use arrows to show shifts of curves and the change in the price level and output.

The two shocks are: The stock market falls in value. Technology makes it cheaper to produce goods like toys and electronics that use plastic.

Answer 1

The stock market falls in value. This reduces wealth of consumers. They reduce consumption so aggregate demand decreases. In short run AD shifts left. Price level and output both decline. The new short run equilibrium is at F. In the long run wages adjust so that production is increased. SRAS shifts right as aggregate supply increases. Price level is down further but output rises. New long run equilibrium is at G.

Technology makes it cheaper to produce goods like toys and electronics that use plastic. This raises short run production. Aggregate supply increases and so SRAS shifts right. Price level falls and output rises in short run. New short run equilibrium is at F. In the long run wages adjust so that production is decreased. SRAS shifts left as aggregate supply decreases. Price level is now increased but output falls. New long run equilibrium is same as old equilibrium at E.