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Suppose most business CEOs expect a slowdown in the economy. How would this situation affect the...

Suppose most business CEOs expect a slowdown in the economy. How would this situation affect the economy?

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Answer #1

A slowdown expected by business leaders leads to lower business investment, which decreases aggregate demand in short run. AD curve shifts leftward, decreasing both price level and output which gives rise to a short run expansionary gap.

In following graph, AD0, LRAS0 and SRAS0 are initial aggregate demand, long-run aggregate supply and short-run aggregate supply curves intersecting at point A with long-run equilibrium price level P0 and output (real GDP = potential GDP) Y0. As business outlook declines, investment falls and AD decreases, AD0 shifts leftward to AD1, intersecting SRAS0 at point B with lower price level P1 and lower output Y1, giving rise to a recessionary gap equal to (Y0 - Y1) in short run.

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