Answer to Question #210936 in Macroeconomics for Jai

Question

Suppose following the lockdown the stock market declines sharply, reducing consumers’ wealth, explain with the help of a diagram what will be the short-run and long-run effects on output and the price level, assuming policymakers take no other action. [4 marks]

                                    

Answer 1

In the short run, the real output and price level will both decrease. The wealth of consumers decreases as a result of lockdown since they are not working which will thus decrease the consumption level. The aggregate demand will then decrease meaning that it will shift to the left. The output will reduce from Y1 to Y2 and the price will reduce from P1 to P2 as the aggregate demand shifts from AD1 to AD2.

In the long run, the economy is at full employment, thus only the price level will reduce as the wealth of consumers decrease. At full employment, the aggregate supply is vertical.