Question

Graph this question.

Consider the aggregate demand and aggregate supply model from class. Suppose that the economy is initially in short-run and long-run equilibrium. Suppose then that a hurricane hits the entire East coast of the US, destroying half of the orange growing trees in Florida. What happens to inflation and output from these changes in the short-run? What happens to these variables in the long-run?

Answer 1

Due to hurricane in the US half of the orange growing trees destroyed which cause aggregate supply curve to shift leftward to SRAS₂ from SRAS₁ as less trees can supply less amount of oranges. The reduced supply will take prices up to P*₂ from P*₁ and output falls to Y2 from Y1 in short run. The new equilibrium will be E2

However, in the long run, the increase in unemployment rate caused due to fall in national output will reduce wage rate in the economy and thus reduce cost of production shifting the SRAS₂ curve back to SRAS₁ and thus new long run equilibrium in the economy is restored at point E1 where price level has fallen to initial level and output is at its potential level.

LRAS SRAS2 SRAS Price Level E2, p*2 p*1 E1 AD Y1 Output Y2