Chapter 27, Problem 1QFR

To determine

To explain:

The reason for shift in long-run aggregate demand and supply curves during Great Recession.

Explanation of Solution

During Great Recession, undoubtedly long-run aggregate demand falls which causes this curve to shift leftward. Similarly, the long-run aggregate supply also falls causing this curve shifts leftward. Behind this there are of course some causes. These are as follows:

Causes of shift of long run aggregate demand curve are explained below:

• Higher interest rates: It reduces borrowing and investment level.
• Fall in real wages:Real wages falls in the form of cutting wages by firms as inflation rate erodes real wages value.
• Fall in consumer confidence:This is in the form of negative sequence of events causing delay in consumer spending. Lesser confidence minimizes investment in business too.
• Credit crunch: This causes a fall in advancing loans by banks and consequently lesser investment.
• A period of deflation. Reducing price levels often inspire people for delayed spending. Besides, deflation adds the actual value of debt more which results in worse off situation of the debtors.
• Exchange rate appreciation:This makes exports more costly and finally decreases export demand.

The situation of leftward shift of aggregate demand is shown diagrammatically on Figure 1.

  

Figure 1

Cause of shift of long run aggregate supply curve is explained below:

• Rise in oil prices: Oil price hike is the only main reason forleftward shift of long run aggregate supply curve. This leads to high production cost and ultimately collective supply in the economy to decline.

The situation of leftward shift of aggregate demand is shown diagrammatically on Figure 2.

  

Figure 2

Economics Concept Introduction

Great Recession:

Great Recession is the term that represents the rapid downfall of economic activities in world economy towards last of 2000s. The magnitude and consequent harm of recession were distinct in different countries.The developed countries like North America and Europe were affected a lot and developing countries like India and China faced development in their economy.