DSE PP-13

Figure 4 shows the aggregate supply and aggregate demand curves of an economy.

Suppose the initial equilibrium is at E₀.

(a) Why is the short run aggregate supply curve upward-sloping? (3 marks)

(b) Suppose the economy suffers from a bursting of the assets bubble so that asset prices fall drastically. With the aid of Figure 4, explain how the short run equilibrium output and price levels of the economy will change. (6 marks)

(c) With the aid of Figure 4, explain how market forces will help restore the output level to Y_f. (5 marks)