Question

What caused the Great Recession to occur in 2008, and as result, what happened to equilibrium real GDP, the unemployment rate,and the price level? Using the aggregate demand and aggregate supply model to explain what caused this.

Answer 1

It was all started with sub prime mortagage lending crisis as a result the prices of houses went down, the aggregate demand and the aggregate supply both fell leading to a higher unemployment and to a lower price level in the economy. The decreased bank lending due to the credit crisis and the shortage of the bank funds has reduced the investment and the consumer spending in the economy. These are the components of the AD and ultimately resulted in a fall in the aggregte demand.

Also the higher oil prices in the early 2008 caused a decline in the production, causes the short run aggregte supply curve shifts to the left.

Initally the economy at the point A, and when the rise in the price of oil rises the short run aggregate supply curve shifts to the left leading to decrease in the GDP and the increase in the price level in the economy. The equilibrium moves to A to point B. But this is not over when the sub-prime mortgage crisis hits the economy it leads to deflationary situations in the economy due to the lack of consumer spending and investment this created a decreased aggregte demand leading to a leftward shift in the aggregate demand curve. So when this happens the price level in the economy falls and the GDP falls further down, leading to a recession.