From the short run to the long run The following graph shows the economy in long

Question

From the short run to the long run The following graph shows the economy in long-run equilibrium with real GDP equal to $10 billion and a price level of 100. Suppose the velocity of money decreases. Use the green line (triangle symbols) to show the new position of the affected curve on the graph. On the graph, use the black point (X symbol) to indicate the short-run equilibrium, and then place the red point (cross symbol) to indicate the new long-run equilibrium. Dashed drop lines will automatically extend to both axes. Which of the following statements best describes the short-run affect of the change in velocity? Higher prices cause output to decreases, moving the economy up along the Ad curve. Lower prices cause output to increase, making the economy down along the AD curve. Fixed output levels force price to increase, moving the economy down along the LPAS curve. Fixed prices force output to decline, moving the economy left along the SRAS curve. In the long run, further adjustments occur in the economy that bring it into long-run equilibrium. Which of the following statements best describes how the economy transitions from the short run to the long run? Output falls, moving the economy left along the SRAS curve. Output rises moving the economy right along the SRAS curve. Wages and prices fall, moving the economy down along the AD curve Wages and prices rise, moving the economy up along the CRAS curve

Explanation / Answer

This picture is in very low resolution and very hard to read or see the diagarm.

a) Price Quantity theory states that

PQ = MV

So if velocity of money decreases and prices are fixed then obviously quantity will be lower and in turn output. This will be sort of contraction in short term and will shift AS-AD.

b) To achieve equilibrium point in the long run, prices and wages will have to fall which will create demand at lower levels.

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