Economic fluctuations

The following graph shows the short-run aggregate supply curve (AS), the aggregate demand curve (AD), and a vertical line at potential GDP representing the long-run aggregate supply curve for a hypothetical economy. Initially, the expected price level is equal to the actual price level, and the economy is in long-run equilibrium at its potential GDP, $110 billion.

Suppose a bout of severe weather drives up agricultural costs, increases the costs of transporting goods and services, and increases the costs of producing goods and services in this economy.

Use the graph that follows to help you answer the questions about the short-run and long-run effects of the increase in production costs. (Note: You will not be graded on any adjustments made to the graph.)

Hint: For simplicity, ignore any possible impact of the severe weather on potential GDP.

130 Potential GDP O 125 AS AD 120 115 AS 110 A PRICE LEVEL 105 Potential GDP 100 AD 95 90 90 95 100 105 110 115 120 125 130 OUTPUT (Billions of dollars)