Question

Stock market prices plunged tremendously in 1929, contributing to the Great Depression as the AD curve shifted greatly to the left. The ordinary AS/AD model predicts that a falling short-run aggregate supply would bring deflation and move the economy back to potential output. Which of the following describes the impact of dynamic feedback effects on this return to potential output?

a. expectations that stock prices would rise back again would cause the AD curve to shift left.
b. expectations that stock prices would fall further could shift the AD curve further to the left.
c. expectations that stock prices will fall further would cause the AD curve to shift to the right.
d. falling stock prices would make people feel poorer which would cause the AD curve to shift to the right.

Answer 1

b. expectations that stock prices would fall further could shift the AD curve further to the left.

Step-by-step explanation:

The AS/ AD model stated the aggregate supply and aggregate demand model which stated level of prices and its output by maintaining the relation between the supply and demand

As in the given situation, it is mentioned that the aggregate supply of short run decline and that brings deflation and it moves the economy back to the output i.e potential. It impacts the expectation of stock prices would result in declines and further it shifted the AD curve to the left side

Hence, the correct option is B.