The following graph shows the economy in long-run equilibrium at the expected price level of 120 and the natural level of output of $600 billion. Suppose firms become pessimistic about future business conditions and cut back on investment spending.

Shift the short-run aggregate supply (AS) curve or the aggregate demand (AD) curve to show theshort-runimpact of the business pessimism.

In the short run, the decrease in investment spending associated with business pessimism causes the price level to Rise/Fall below the price level people expected and the quantity of output to Rise above/Fall below the natural level of output. The business pessimism will cause the unemployment rate to Rise above/fall belowthe natural rate of unemployment in the short run.

Again, the following graph shows the economy in long-run equilibrium at the expected price level of 120 and the natural level of output of $600 billion, before the decrease in investment spending associated with business pessimism.

During the transition from the short run to the long run, price-level expectations willadjust upward/ adjust downward/ remain the sameand the short-run aggregate supplycurve will shift to the left/right.

240 O AS 200 AD 160 AS 120 PRICE LEVEL 80 AD 40 0 0 200 400 600 800 1000 1200 OUTPUT (Billions of dollars)