In the short run as per the classical view, recessionary gaps (represented by region ADB to ADA in the graph) and inflationary gaps (represented by region ADB to ADC) are possible due to wage inflexibility. Factors such as labor contracts, unemployment benefits, and minimum wages limit the ability of firms to adjust wages in the short run. Therefore, it is not viable for firms to cut wages in response to reduced demand. In this regard, a fall in demand due to the real estate bubble bursting and ensuing fall in real estate prices forces firms to accept a new equilibrium characterized by lower output than the full employment output level, and hence higher unemployment. This scenario is a deflationary gap or recessionary gap as shown at writing essay help. The burst leads to a shift in the aggregate demand curve from ADB to ADA. In a simplified scenario, workers would realize that their high wage demands are unwarranted and lower their wage expectations to reflect the new reality. As such, firms would then produce more at lower labor costs, leading to a shift in the supply curve to the right from SASE to SASD. Such self-adjustment would guide the return to long run potential output.
In reality, however, the return to long run potential output is not as simple as it can be complicated by feedback effects in the AS/AD model due to non-market factors or externalities. Markets tend to be inherently open. Therefore, markets that are tangentially involved with a given market have a significant impact on the latter with the potential for asymmetric effects. The financial crisis set off by the real estate bubble burst provides an example of this scenario. Under the classical view as suggested above, production costs would self-adjust to direct the real estate market to long run equilibrium. However, the financial crisis has a ripple effect through the economy with major implications for the real estate market. Households might opt to save more due to the experience with the burble bursting. The financial market, reeling under the impact of the crisis, might reduce financing and suppress demand for real estate. Ideally, the supply curve would shift to the right from SASE to SASD such that firms produce more at lower cost, but the suppressed demand might lead firms to cut supply. The market should self-regulate to reach equilibrium, but the feedback effects due to external factors from interconnected markets imply that the real estate market might never attain long run potential output. Get nursing essay help urgently.
