Question

the graph shows keyness theory of aggregate demand.
graph: price (y-axis), total economic output (x-axis). curves: supply (long run, vertical), supply (short run, upward-sloping), demand (downward-sloping). intersection at equilibrium.
what is likely to happen if a new aggregate demand curve moves to the right?

• prices and output would drop, and the equilibrium point will stay the same.
• prices would rise, and output would drop in the short run.
• prices and output would rise, and the equilibrium point will change.
• prices would rise, and output would drop in the long run.

Explanation:

In Keynesian aggregate demand - aggregate supply analysis, when the aggregate demand (AD) curve shifts to the right, we analyze the impact on price and output:

1. Understand AD - AS Interaction: The short - run aggregate supply (SRAS) curve is upward - sloping (as in the given graph), and the long - run aggregate supply (LRAS) is vertical. When AD shifts right (new AD curve), at the initial price level, there is an excess demand for goods and services.
2. Short - Run Impact: Firms respond to the increased demand by increasing output (since in the short run, they can adjust production levels) and also by raising prices (as demand outstrips supply at the original price). This leads to a new equilibrium point where both the price level and the total economic output (real GDP) are higher than before. The equilibrium point (the intersection of the new AD and SRAS) changes.
3. Evaluate Options:

• Option 1: Prices and output dropping with the same equilibrium is incorrect. A rightward AD shift increases demand, so output and prices should rise, and equilibrium changes.
• Option 2: Output dropping in the short run is incorrect. In the short run, with increased demand, firms will increase output.
• Option 3: When AD shifts right, in the short run (with the upward - sloping SRAS), the new equilibrium from the intersection of the new AD and SRAS will have a higher price and higher output, and the equilibrium point changes. This is correct.
• Option 4: In the long run, if we consider the full - adjustment, but the question is about the impact of a new AD curve moving right (the process of adjustment starts with the short - run impact first, and the option's description of output dropping in the long run due to a rightward AD shift is incorrect. A rightward AD shift in the long run (with LRAS vertical) will only increase prices, but the option's description of output dropping is wrong.

Answer:

C. Prices and output would rise, and the equilibrium point will change. (Here we assume the options are labeled A, B, C, D with the third option being C. If the original options have different labels, adjust accordingly. Based on the content, the correct option is the one stating "Prices and output would rise, and the equilibrium point will change.")