Question

AS-AD Diagrams.

a) The 2008 Recession was largely a reduction in investment demand and consumption. Show how this would look on an AD-SRAS graph with RGDP on the horizontal and Price Index on the vertical. Indicate what would be expected to happen to output and the price level.    

b) Our current macroeconomic situation has a similar reduction in investment and consumption, but we are also seeing a sectors unable to produce goods because workers are too sick or worried about getting sick to come to work and because production of important inputs has been interrupted. Show how this would look on an AD-SRAS graph with RGDP on the horizontal and Price Index on the vertical. Indicate what would be expected to happen to output and the price level.

Answer 1

a)

In panel (a) initial equilibrium is at point E where AD and SRAS intersect. Due to slack in consumption, investment, the AD curve shift to the left from AD to AD1. The new equilibrium is at point E1 where both output and price level are at lower level. This is called the recessionary gap situation.

Recessionary Gap = Y1 and Y2 distance.

So, both price and output decreases

b)

In panel (b) the SRAS curve shifts upward from SRAS to SRAS1 due to disruption in supply chain. Econmoy moves to equilibrium point E1.

As a result of this, output falls more than the situation in part a.

Price level however show a little increase indicating some level of inflation.