Suppose an Economy Is in Recession

Question

Examlex · Accepted Answer

The Answer is The graph below depicts an economy in a recession. The short-run aggregate supply curve is AS₁ and the economy is in equilibrium at point A, which is to the left of the long-run aggregate supply curve. If policymakers take no action, the economy will return to the long-run aggregate supply curve over time since the actual price level will be below the price level that people expected. Individuals will eventually correct their expectations about the price level. As they do so, prices and wages will adjust accordingly, shifting the aggregate supply curve to the right to AS₂. The economy's new equilibrium is at point B. The rightward shift in aggregate supply eventually causes output to rise back to the natural rate.

The graph below depicts an economy in a recession. The short-run aggregate supply curve is AS<sub>1</sub> and the economy is in equilibrium at point A, which is to the left of the long-run aggregate supply curve. If policymakers take no action, the economy will return to the long-run aggregate supply curve over time since the actual price level will be below the price level that people expected. Individuals will eventually correct their expectations about the price level. As they do so, prices and wages will adjust accordingly, shifting the aggregate supply curve to the right to AS<sub>2</sub>. The economy's new equilibrium is at point B. The rightward shift in aggregate supply eventually causes output to rise back to the natural rate.

Suppose an Economy Is in Recession

Definitions: