Question 1:

a.[5 marks] Explain the three reasons why the AD curve slopes downward. State an event that will shift the AD curve, which way it will shift the AD?

b.[5 marks] Suppose that the economy is in LR equilibrium. Draw a carefully labeled AD-AS diagram to show the initial LR equilibrium.

c.[5 marks] Show on the above diagram the effect of a drought that destroys crops of many farmers. Carefully explain all 4 steps to show and explain what will happen in the short run? What is this situation called? How the economy will arrive back to its LR equilibrium without any policy involvement. Make sure to include all the relevant details.