Using a diagram and written explanation explain the combined consequences of a increase in potential output...

Using a diagram and written explanation explain the combined consequences of a increase in potential output shcok and a positive inflation shock.

Solutions

Expert Solution

Increase in potential output shock means positive supply shock. So aggregate supply curve shifts to the right. On the other hand, positive inflation shock means a decrease in supply, shift of the supply curve upward that is negative supply shock, so that inflation to rise.

Case1: Positive supply shock is more than the negative supply shock

In this case, supply will be increased and aggregate supply curve shifts to the right, resulting in an increase in quantity and decrease in price.

Case 2: Negative supply shock is more than the positive supply shock

In this case supply curve shifts to the left. As a result, the price will be increased and quantity will be decreased

Case 3: Negative supply shock is equal to the positive supply shock

In this case, the supply curve will not be changed. So market equilibrium will not be changed.

Rahul Sunny answered 1 year ago

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