This Problem Compares Two Economies: Economy A, Having a Lower

Essay

This problem compares two economies: Economy A, having a lower elasticity of the short-run aggregate-supply curve, and economy B, with higher elasticity. Draw a graph representing an aggregate-demand curve and two short-run aggregate-supply curves, ASA and ASB, such that ASB is flatter than ASA. Both economies are in long-run equilibrium at the same output and price level. Suppose a sharp decline in the housing prices and a subsequent financial meltdown reduces the aggregate demand by the same amount in both economies. Use the graph to explain the differences in output and price declines in the two economies. What do we learn from this exercise?