Question

In Chapter 14 we adopt the AS/AD model to study the Great Recession and the Great Depression. What are the shortcomings of the AS/AD model in explaining the two episodes of recession? Briefly explain. (10 pts)

Answer 1

We can use AD AS model to understand any changes in the real GDP, price level in the short run as well as long run. In the short run if the economy experiences recession, the real GDP falls from the equilibrium level of output. But in the long run growth, there are so many factors responsible for resurgent of economy from recession which do not appear in the AD AS model.

The great recession of 2008 affects all over the world. Actually it began in 2006 by bursting housing bubble and subprime lending crisis... It led to huge unemployment, price falls, a decrease in GDP etc. Financial market and international trade badly affected... All these things cannot explain with the help of AD AS model. It can only explain the price output relationship... Great recession is an international problem so it affects all aspects of the world economy. So we need to examine ISLMBP, ISMP,ISLMFX,ISLMPC and Phillips curve etc.