Draw the graph · Macro · Aggregate demand and aggregate supply
The stock market crashes
Drag a curve sideways, or use its arrows. A curve you do not move is a curve you are saying stays put. Make each shift clear enough that a reader could see it.
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Aggregate demand shifts left. Short-run aggregate supply stays put. Long-run aggregate supply stays put.
When wealth falls, households consume less at every price level. Consumption is a component of aggregate demand, so AD shifts left. Firms' costs and the economy's capacity are unchanged. Output falls below potential.
The price level falls and real GDP falls, opening a recessionary gap.
Common mistake. Students sometimes shift LRAS left because 'the economy lost wealth.' Stock prices are not the economy's resources or technology. The crash works through spending, so the shift is in AD.
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Lesson: Aggregate Demand