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 to ),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  to  ),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 moves to a short-run equilibrium at point B where output decreases and prices fall. As prices fall, firms reduce their costs and this leads to a rightward shift of the AS curve. This process continues until the economy reaches a new long-run equilibrium at point E, where output has returned to its potential level (1000) and prices have fallen to a lower level than before the shock. Therefore, option B is the correct answer as wages would eventually fall, causing the AS curve to shift slowly to the right, reaching a new equilibrium at point E.

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