Question

Fears of a global COVID-19 pandemic cause investors’ anxiety and panic about economic prospect. Unprecedented stock-market crashes occurred.

a. Draw and attach an AD&AS diagram below to show what happens to output and the price level in the short run in response to the stock-market decline.

b. Predict what will happen to output and the price level in the long run?

Answer 1

A)

Stock market crash will decrease wealth of household.

Decrease in wealth will decrease CONSUMER confidence index and thus Decrease autonomous consumption.

Decrease in autonomous consumption will decrease aggregate expenditure and aggregate demand and AD curve shift left.

As a result output and prices Decrease

B) Deceasing prices and high unemployment will lead to lower wages .

Lower wages Decrease Production cost of firms ,which lead to increase in aggregate supply and SRAS shift right.

As a result output Increases to potential GDP ( LRAS or Yn) and price Level Decrease further.