Determine the impact of the each of following types of shocks on output and inflation in the short-run and long-run. (Use AS-AD-LRAS curves to illustrate your reasoning).

Question

Determine the impact of the each of following types of shocks on output and inflation in the short-run and long-run. (Use AS-AD-LRAS curves to illustrate your reasoning).

a. A decline in consumer confidence.

b. An increase in inflation expectations.

c. An increase in export demand.

Answer 1

Hi Clay,

Determine the impact of the each of following types of shocks on output and inflation in the short-run and long-run. (Use AS-AD-LRAS curves to illustrate your reasoning).

Think about the components of your AD curve - C + I + G + Nx. Think about the reasons why suppliers would increase or decrease supply.

a. A decline in consumer confidence.

1. Decline in consumer confidence(decrease in C) will cause a negative demand shock - shifting the AD curve left decreasing the price level. In the long run this will correct itself, the decreasing price level will encourage decreasing labor costs which will cause the SRAS to shift right.

b. An increase in inflation expectations.

1. An increase in inflation expectations will cause producers to produce less now preparing for higher prices in the future causing a negative supply shock - shifting the SRAS curve left - increasing inflation and unemployment. In the long run, this will also correct itself, an increase in unemployment will lead to lower wages, increasing SRAS.

c. An increase in export demand.

1. An increase in export demand(increase in Nx) will cause a positive demand shock - shifting the AD curve right. In the long run, try to figure this one out yourself - in problem a. we dealt with a negative demand shock, so do the opposite.