Refer to Figure 15.3 and explain what happens in each graph when an economy is moving from a ...

If the economy is in a recession at point a, wages and prices will start to fall (P0 to P1) . Short-run aggregate supply will shift down, increasing output from y0 to yF and moving the economy from point a to point b in panel (A). In panel (B), the fall in price level will decrease the demand for holding money, shifting the money demand curve down and moving the economy from point c to point d. This will cause interest rates to fall from r0 to r1. When interest rates fall from r0 to r1, investment spending will increase from I0 to I1, moving the economy from point e to point f in panel (C).