The diagram below shows an AD/AS model for a hypothetical economy.The economy begins in long-run equilibrium at point A.
FIGURE 24-3
-Refer to Figure 24-3.After the negative aggregate demand shock shown in the diagram (from AD1 to AD2),which of the following describes the adjustment process that would return the economy to its long -run equilibrium?
A)Wages would eventually fall,causing the AD curve to shift to the right,returning to the original equilibrium at point A.
B)Wages would eventually fall,causing the AS curve to shift slowly to the right,reaching a new equilibrium at point E.
C)Wages would increase,causing the AS curve to shift to the right,reaching a new equilibrium at point E.
D)Wages would increase,causing the AD curve to shift to the right,returning to the original equilibrium at point A.
E)Potential output would decrease from 1000 to 900 and a new long -run equilibrium would be established at point D.

Question

The diagram below shows an AD/AS model for a hypothetical economy.The economy begins in long-run equilibrium at point A.
  FIGURE 24-3
-Refer to Figure 24-3.After the negative aggregate demand shock shown in the diagram (from AD1 to AD2),which of the following describes the adjustment process that would return the economy to its long -run equilibrium?
A)Wages would eventually fall,causing the AD curve to shift to the right,returning to the original equilibrium at point A. 
B)Wages would eventually fall,causing the AS curve to shift slowly to the right,reaching a new equilibrium at point E. 
C)Wages would increase,causing the AS curve to shift to the right,reaching a new equilibrium at point E. 
D)Wages would increase,causing the AD curve to shift to the right,returning to the original equilibrium at point A. 
E)Potential output would decrease from 1000 to 900 and a new long -run equilibrium would be established at point D.

Quizplus · Accepted Answer

After the negative aggregate demand shock, the economy experiences a short-run decrease in output and an increase in unemployment. This creates downward pressure on wages, causing them to eventually fall. As wages fall, firms are willing to produce more at any given price level, causing the AS curve to slowly shift to the right. This process continues until the economy reaches a new long-run equilibrium at point E, where output returns to its potential level of 1000 and the price level is lower than the original equilibrium at point A. Therefore, the best choice is B.

The Diagram Below Shows an AD/AS Model for a Hypothetical