Question

 For each of the following situations, use the AD/AS model to describe what happens to the price level and output in the United

 States in the short run. In each case, assume the economy starts in long-run equilibrium, and describe the appropriate shift in the AS or

 AD curve.

 Instructions: You may select more than one answer. Click the box with a check mark for correct answers and click to empty the box for

 the wrong answers.

 a. A stock market crash reduces people's wealth.

 Aggregate demand shifts to the left.

 Aggregate demand shifts to the right.

 Aggregate supply shifts to the left.

 2 Aggregate supply shifts to the right.

 Output falls.

 Output rises.

 The price level rises.

 The price level falls.

 b. The spread of democracy around the world increases consumer confidence in the United States.

 ? Aggregate demand shifts to the left.

 Aggregate demand shifts to the right.

 2 Aggregate supply shifts to the left.

 Aggregate supply shifts to the right.

 Output falls.

 Output rises.

 The price level rises.

 The price level falls.

 c. The European economy crashes.

 Aggregate demand shifts to the left.

 7 Aggregate demand shifts to the right.

 Aggregate supply shifts to the right.

 Aggregate supply shifts to the left.

 Output falls.

 Output rises.

 The price level falls.

 The price level rises.

 d. The United States enters into an arms race with China, resulting in a significant increase in military spending.

 Aggregate demand shifts to the left.

 Aggregate demand shifts to the right.

 Aggregate supply shifts to the right.

 Aggregate supply shifts to the left.

 Output falls.

 Output rises.

 The price level falls.

 The price level rises.

Answer 1

A) A stock market crash reduces people’s wealth. It will result in less disposable income into hands and will shift the AD curve to the left. As a result output and price level falls in the short run.

So,:

aggregate demand shifts to left,

output falls, and

price level falls.

B) The spread of democracy around the world increases consumer confidence in the US. This will lead to an increase in exports and investments as well. There is an inflow of capital which creates a threat for the US currency.

But in the short run the result is:

Aggregate demand shifts to right,

price level increases and

output level increases

C) The European economy crashes will actually only impact demand, so the supply shift would not shift. Aggregate demand shift leftwards and as a result the price level falls and the output level will fall.

D) The US increasing military spending is an increase in government spending, thus an increase in GDP. So demand would shift to the right, output would rise, and price levels would rise.