Suppose the economy is initially in long-run equilibrium. Now, due to a decline in house prices, consumers reduce their consumption spending.
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 inflation shock.
i. Explain how the adverse inflation shock affects the AS curve.
ii. Discuss, using AD-AS diagrams, what choices the government now must make regarding stabilization policy.