The figure given below shows short run and long run equilibrium in an aggregate demand-aggregate supply model. The economy shown in this figure is:

A) in a long-run equilibrium at the price level P and income level Y.
B) in a short-run equilibrium at the price level P and income level Y.
C) experiencing a contractionary gap at price level P and income level Y.
D) experiencing an expansionary gap at price level P" and income level Y'.
E) in a short-run equilibrium at the price level P' and income level Y.

Question

The figure given below shows short run and long run equilibrium in an aggregate demand-aggregate supply model. The economy shown in this figure is:

A) in a long-run equilibrium at the price level P and income level Y. 
B) in a short-run equilibrium at the price level P and income level Y. 
C) experiencing a contractionary gap at price level P and income level Y. 
D) experiencing an expansionary gap at price level P" and income level Y'. 
E) in a short-run equilibrium at the price level P' and income level Y.

Quizplus · Accepted Answer

The economy is in a short-run equilibrium at the price level P and income level Y. This is seen as the point where aggregate demand intersects with short-run aggregate supply (AD1 and SRAS1). In the long-run, the economy will move towards potential output (Yp) at the natural rate of unemployment and with a flexible price level. However, we cannot infer from the graph alone whether the economy is experiencing a contractionary or expansionary gap as we do not have information on potential output.

The Figure Given Below Shows Short Run and Long Run