Figure 14.3

-Refer to Figure 14.3.Suppose the economy is initially at long-run equilibrium and the economy experiences a demand shock such as a stock market crash.The economy then reaches a new,short-run equilibrium point.Assuming expectations are adaptive,this will allow the central bank to decrease the real interest rate,moving the economy to a another new equilibrium point.The stock market crash is temporary,so as the economy works its way back to long-run equilibrium,real GDP will increase.As the expected rate of inflation changes,the economy will move from

Question

Figure 14.3

-Refer to Figure 14.3.Suppose the economy is initially at long-run equilibrium and the economy experiences a demand shock such as a stock market crash.The economy then reaches a new,short-run equilibrium point.Assuming expectations are adaptive,this will allow the central bank to decrease the real interest rate,moving the economy to a another new equilibrium point.The stock market crash is temporary,so as the economy works its way back to long-run equilibrium,real GDP will increase.As the expected rate of inflation changes,the economy will move from

Quizplus · Accepted Answer

The demand shock causes a decrease in output and an increase in the price level, shifting the economy from point A to point D. The adaptive expectations allow the central bank to decrease the real interest rate, which shifts the economy from point D to point C. As the economy adjusts back to long-run equilibrium, real GDP will increase, and the economy will move from point C to point B. However, the expected rate of inflation will also change, which will shift the economy from point B to point C. Therefore, the correct answer is D, which represents the path the economy takes after the demand shock.

Figure 14.3 -Refer to Figure 14.3.Suppose the Economy Is Initially at Long-Run