Question

The economy is at point "A" according to the AD-AS model as depicted in the figure. By what mechanism will the economy return to Y* (assuming no policy intervention)? Nominal wage increases due to overemployment, increasing AD Nominal wage decreases due to unemployment, increasing AS The price level increases, leading firms to produce more and increase AS The price level decreases, leading consumers to consume more and increase AD Please explain the reason.

Answer 1

Answer
the vertical curve is the long-run aggregate supply curve as it is vertical at the potential output
the upward sloping curve is the short-run aggregate supply curve
the downward sloping curve is an aggregate demand curve

on the x-axis, there is real output and on the vertical axis, there is a price level.

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The point A represents recessionary gap as the LRAS is right of the point means the actual real GDP is less than the potential real GDP.
The less output than the full employment level has recession where money in the hand of people decreases and that decreases income levels which increases people to work more at fewer wages and that increases the SRAS which shifts to the right and increases the real output equal to the potential output in the long run.