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Answer This Now*** 2. Graphically illustrate and explain the impact of a decrease in aggregate demand...

Answer This Now***
2. Graphically illustrate and explain the impact of a decrease in aggregate demand on the economy’s equilibrium price and real output, assuming that the economy is currently operating at its full-employment output level and the price level is flexible upward but not downward. How would theanalysis be different if the price level is flexible downward?
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Answer #1

In the below diagram, O1 is the full employment equilibrium level. The economy was initially at point A, with demand level AD1. With a reduction in aggregate demand, the aggregate demand curve moves downward towards AD2. When the price is inflexible for being down, the economy will operate at point B with the constant price level and lower real output at O2.

If the price is flexible to move down, the economy will operate at point C with the lower price level P2 and operating at full employment equilibrium.

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