Question

The aggregate demand / aggregate supply model 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 super vaccine for everyone to be safe from deadly viruses, raising productivity. This makes consumers and businesses optimistic about the economy. At the same time, the 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 the short run? And what would happen to price level and output in the economy?

What about the long run?

Explain in words.

Answer 1

Economy is at its long run equilibrium level when short supply curve = long run supply curve = demand.

Inventing new vaccine which raise productivity will help producers in producing more goods with using same raw material and inputs. Additionally there is no change in oil prices. It will raise aggregate supply of goods which will shift supply curve to its right from AS to AS1 which will reduce price from P to P1 and raise output level from Y to Y1 in short run.

In long run, consumers will raise their demand of goods because goods are available at lower prices. It will shift demand curve to its right which raise price to its initial level and raise output level further.