Suppose the economy is initially in long-run equilibrium. Now, due to a decline in house prices, consumers reduce their consumption spending. ( LO5 )

a. Explain how the decline in consumer spending affects the AD curve.

b. Explain how your answer to part a affects the economy’s short-run equilibrium.

Use an AD-AS diagram to illustrate your answer.

c. Now, in addition to the decline in consumer spending, suppose that the economy experiences a negative price shock.

i. Explain how the adverse price shock affects the AS curve.

ii. Discuss, using AD-AS diagrams, what choices the government now must make regarding stabilization policy.