Using the aggregate demand-aggregate supply model, predict what happens in the short run when the consumer confidence index falls as consumers become pessimistic about their economic prospects.

Question

BlackTom AI · Accepted Answer

To tackle this question, we first identify the scenario: a fall in the consumer confidence index implies households are pessimistic about the economy, which tends to reduce current and future spending. Now, evaluate each option in light of how AD and AS respond in the short run.

Option a: The aggregate supply curve shifts left; the aggregate demand curve is not affected; price level increases; real GDP decreases.
- This is incorrect because consumer confidence primarily affects demand, not the supply side. A shift in aggregate supply would require a change in production costs or capacity, which isn’t implied by pessimism about prospects. Also, with demand not affected, there would be no reason for the price level to rise merely due to lower demand.

Option b: The aggregate demand curve shifts left; the aggregate supply curve is not affected; price level and real GDP decrease.
- This aligns with standard AD-AS analysis: decreased consumption reduces aggregate demand, shifting the AD curve left. In the short run, AS remains unchanged, so the new equilibrium features a lower price level and lower real GDP if the price level does not adjust upward due to supply conditions. The key idea is demand-driven slowdown without an immediate supply response.

Option c: The aggregate supply curve shifts right; the aggregate demand curve is not affected; price level decreases; real GDP increases.
- This contradicts the scenario. An improvement in confidence would shift AD to the right, not left, and a rightward shift of AS is not implied by pessimism. Moreover, GDP increasing while confidence is falling is inconsistent with a demand-driven deterioration.

Option d: The aggregate demand curve shifts right; the aggregate supply curve is not affected; price level and real GDP increase.
- This is the opposite of what pessimism does. A shift of AD to the right would come from increased spending, not from decreased confidence. So both the direction of shift and the resulting outcomes (increases) conflict with the scenario.

Option e: The aggregate demand curve shifts left; the aggregate supply curve adjusts by moving left, and real output decreases, while prices are unaffected.
- Here, the AD shift left is correct, but AS moving left (a leftward shift) is not warranted by falling confidence. AS typically remains fixed in the short run unless there are supply-side shocks. Also, prices being unaffected is inconsistent with most AD-AS outcomes where a leftward AD shift tends to change the price level.

In summary, only options that correctly capture a leftward shift of AD with AS unchanged, leading to lower real GDP and typically a lower price level (in the short run), are consistent with the described fall in consumer confidence. The most accurate depiction among the choices is the one that keeps AS unchanged while AD shifts left and results in lower output and lower or unchanged prices depending on the specific supply response, while avoiding incorrect implications about AS shifts or price changes.

Academic Courses Test#3

Using the aggregate demand-aggregate supply model, predict what happens in the short run when the consumer confidence index falls as consumers become pessimistic about their economic prospects.

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