The Great Depression was the worst economic crises to hit the globe economy, lasting from 1929...

The Great Depression was the worst economic crises to hit the globe economy, lasting from 1929 to 1939. During this period: (i) the US stock market crashed which caused pessimism to grow; (ii) banks failed, which led to consumers losing their deposits, and a gap between savings and investment; (iii) Fed allowed money supply to plunge by nearly 30%. Assume that these three changes are permanent and there were no fiscal or monetary policy response.

a. If the stock market crash caused pessimism to grow amongst consumers and investors, how will this affect aggregate demand in the economy?

b. How does this bank failure affect demand for investment at a given interest rate?

c. Use the AS/AD model to demonstrate the short-run impact of the Great Depression on the Aggregate Demand (AD) curve, the short-run Aggregate Supply curve (AS), real GDP, price level and unemployment. Your answer should include:

i. An AS/AD graph with all curves and quantities clearly labeled. For curves and quantities that change, label their pre-crisis values with a “0” subscript and their post-crisis values with a “1” subscript. For curves and quantities that don’t change, leave out the subscript.

ii. Specific predictions for which variables will go up, which will go down, which will remain the same, and which could go up or down.

d. Use the LRAS/AD model to demonstrate the long-run impact of the global financial crisis on the Aggregate Demand curve, the short-run Aggregate Supply (AS) curve, the long-run aggregate supply (LRAS) curve, real GDP, and the price level. Ignore the effect of reduced investment on the capital stock. Your answer should include:

i. An AS/AD graph with all curves clearly labeled. For curves and quantities that change, label their pre-crisis values with a “0” subscript and their post-crisis values with a “1” subscript. For curves and quantities that don’t change, leave out the subscript.

ii. Specific predictions for which variables will go up, which will go down, which will remain the same, and which could go up or down.

Solutions

Expert Solution

a. A crash in the stock markeet and growing pessimism in the economy would reduce the level of investment expenditure in the economy and decrease in the level of investment expenditure in the economy would reduce the level of aggregate demand in the econopmy.

b. As banks fail in the economy, the demand for investment in the economy would decrease at a given interest rate. Thus, the investment demand curve would shift leftwards.

c.Thus, the diagram depicts short run equilibrum at point E2 where both price level and Real GDP has decreased in the economy and unemployment rate has increased in the economy.

d. An increase in unemployment rate would reduce real wage rate in the economy and also reduce cost of production in the economy shifting the SRAS curve rightwards in the lomg run where prices have decreased in the economy and economy is back to the full employment level and is operating at natural rate of unemployment with a reduced price level.

Rahul Sunny answered 1 year ago

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