Chapter 33, Problem 2FRQ

To determine

The correctly labeled aggregate demand and aggregate supply graph shows an economy in long-run macroeconomic equilibrium

Explanation of Solution

The graph shows long-run macroeconomic equilibrium:

  

The graph illustrates the long-run macroeconomic equilibrium by labeling the aggregate price level on the vertical axis and showing real GDP on the horizontal axis.

Long-run equilibrium is an equilibrium that occurs at a point on the long-run aggregate supply curve when aggregate demand would be equal to the short-run aggregate supply. Under this illustration, the aggregate demand curve would slope downward which increases when there is a price decrease and it is labeled by AD. And Aggregate demand would fall from AD₁ to AD₂ because firms and workers, in the long run, adjust to the price level that is lower than what they expected therefore the cost will decrease and the aggregate demand would shift to the left.

The investment will decrease the aggregate demand due to recession in the long run. Therefore, the aggregate demand would shift to the left.

The graph also indicates that there is an increase in money supply because the supply curve shifts to the right as there would be lower interest rates under the classical model of the price level. Here the classical model of price indicates that the economy is flowing freely and prices can be adjusted according to the ups and downs in the economy such as in good economic conditions, prices will go up.

Economics Concept Introduction

Introduction: An aggregate supply refers to the total supply of goods and services at different price levels (aggregated) in the economy. In simple words, it is the total quantity that is produced and sold by firms at different prices in the market.

The price level is the average current price of goods and services in the economy that are produced in a particular interval.