Question

The aggregate demand aggregate supply mode is quite useful tool for us to understand the economy. So far, we saw only one change at a time, however, in reality, there can be multiple shocks at the same time.

The economy was in long run equilibrium. Assuming all else equal, world scientists collaborated to invent a vaccine for everyone to be safe from deadly virus, raising productivity. This makes consumers and businesses optimist about the economy. At the same time, commodity market, namely oil market is calm, maintaining a stable supply.

Given above scenario, what do you think will happen to the LRAS, SRAS and AD curves in each in short run? And what would happen to price level and output in the economy?

What about in long run?

Explain in words.

Answer 1

Answer - Due to the increase in prodictivity in workers and optimistic consumers , the supply will rise and the consumption will also rise. The LRAS curve will remain constant in short run ,but SRAS curve will shift right and AD will also increased due to optimism of consumer. This will give rise to AD. Thus in short run , inflationary gap will exist leading to rise in price levels and output in economy.

In the long run , due to increase in labor productivity , the LRAS curve will shift right. This will establish the equilibrium in economy eliminating the inflation gap that existed in short run