Question

In early 2001 investment spending sharply declined in the United States. In the 2 months following the September 11, 2001 attacks on the United States, consumption also declined. Use AD-AS analysis to show the two impacts on real GDP.

Short answer

The two impacts on real GDP using AD-AS analysis is shown below:

Step-by-step solution

Explanation

As the investment spending declines sharply in the United States, the AD curve will shift downward, as investment spending is a component of the AD curve. After the attacks on the United States, the consumption fell; thus, the AD curve again fell and shifted leftward. The two impacts will lead to a decrease in real output and a fall in the price level.

Initially, with the fall in investment spending, the AD curve falls from AD₁ to AD₂; after the fall in consumption, the AD curve falls further from AD₂ to AD₃. The price level falls from P₁ to P₃, and quantity falls from Q₁ to Q₃.