Short-Run Equilibrium Changes in Short-Run Equilibrium 1. Using diagrams, show the effects of each of the following on short-run equilibrium, explaining what happens to the (1) equilibrium price level, (2) output, and (3) employment. (a) The price of oil (an important input in production) increases (b) Firms are pessimistic about the future of the economy (c) Below-zero temperatures destroy agricultural output (d) The government lowers taxes on firms' profits (e) There is a large rise in stock market prices (f) The government eliminates subsidies on agricultural products (g) A war destroys a portion of an economy's physical capital Real-World Example The Greek economy still shrinking The Greek economy is expected to contract by 4.8% in 2010. The contraction is mainly due to decreases in consumer and private investment spending, as net exports are showing an improvement. The forecast for 2011 is that the economy will contract a further 3.6%, partly due to drastic cuts in government spending, together with increases in indirect taxes and corporate (business) taxes. Consumer and business confidence are very low. Consumer spending will continue to decrease as unemployment rises and real wages fall. Investment spending is also forecast to fall further. Source: Economist Intelligence Unit, ViewsWire News Analysis, 15 November 2010 1. How do low consumer and business confidence influence aggregate demand? 2. Using a short-run AD-AS diagram, show the effects on aggregate demand of (a) falling consumer, investment and government spending, (b) improved net exports, and (c) increased indirect taxes and business taxes. . Using information in the paragraph above, state two reasons explaining the falls in (a) consumer spending, and (b) investment spending. . Using an AD-AS diagram, explain what kind of output gap the Greek economy was experiencing