If the monetary authority responds to the negative supply shock, what happens to the economy?

A. Aggregate demand shifts left and the price level rises.

B. Aggregate demand shifts right and the price level falls.

C. Both the aggregate demand and supply curves shift to a higher price level.

D. Aggregate demand shifts right and the price level increases.

E. Aggregate supply shifts left and the price level rises.

Solutions

Expert Solution

Correct option is (D).

A negative supply shock shifts aggregate supply curve leftward, which increases price level and decreases real GDP. When monetary authority responds to this situation, it wants to increase real GDP by raising aggregate demand (by increasing money supply and decreasing interest rate, to boost investment and real GDP). So, aggregate demand curve shifts rightward, increasing price level and increasing real GDP.

Rahul Sunny answered 1 year ago

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