Use the AS/AD framework to depict an economy that is a) in equilibrium, and b) operating at full employment.

A. Suppose that expectations concerning the future state of the economy, held by people in the economy’s private sector, become more pessimistic.

B. Illustrate the effects of this “event” on the economy. How should you do this?

Follow a 4-Step Process: Step 1: determine if this event affects AD, SRAS, or LRAS (or some combination of these).

Step 2: determine in which direction the affected curve(s) shifts.

Step 3: draw in the shifted curve(s)—and label it (them) explicitly.

Step 4: locate and label the economy’s new equilibrium Price Level [PL(1)] and its new equilibrium level of Real GDP [Q(1)].

C. Now that your graphical depiction of this event is complete, use it to answer the following questions.

1. Is the new Unemployment Rate higher, lower, or the same as the original Unemployment Rate?

2. Is the Unemployment Rate now greater than, less than, or equal to the “Natural Rate of Unemployment”?

3. Has the economy experienced inflation or deflation?

4. Has the economy experienced economic growth?

5. Has the Business Sector experienced a rise or fall in its level of Unit Labor Costs?

6. Has the level of Imports risen, fallen, remained unchanged, or indeterminate?

7. Has the level of Exports risen, fallen, remained unchanged, or indeterminate?

8. Using your answers to parts 6 & 7, choose the single best answer below: a) The level of Net Exports (X - M) has risen b) The level of Net Exports (X-M) has fallen c) Without additional information we cannot determine what has happened to Net Exports.