Place your mouse cursor over the AD label to drag the Aggregate Demand curve inward or outward to replicate a demand-side shock.
You may drag on the magenta Triangle to alter the Long Run Aggregate Supply (LRAS) position or on the green Triangle to alter the Short Run Aggregate Supply (SRAS) lines.
Press the Self Correcting Equilibrium button or the Monetary Policy Adjustment button to see the appropriate adjustment(s).
Press Reset to start over.
Questions:
Suppose a wave of business optimism causes the aggregate demand (AD) curve to shift to the right and increases the short-run equilibrium level of output in the economy. What is the appropriate response from monetary policymakers to eliminate the output gap created?
Suppose instead that output rises in the economy due to an increase in potential output. What is the appropriate response from monetary policymakers to eliminate the output gap created?
It is often difficult for policymakers to distinguish between an increase in current output, such as that described in question 1, and an increase in potential output, such as that described in question 2. Suppose potential output in the economy increases but policymakers mistake it for an increase in current output. What policy action will they take? How will the economy be affected?
Hit reset to return the graph to its original equilibrium position. Suppose the economy is hit by a negative AD shock, such as a decline in consumer confidence. Assume that at the time this happens, inflation is zero and that the nominal interest rate that policymakers control is close to zero. What happens to inflation in the economy? If policymakers cannot reduce their policy interest rate below zero, what danger does the economy face?
