Question

Q5) i) What would a central bank need to do to reverse the effects of a favorable supply shock on inflation? What would its reaction do to the unemployment rate in the short run?

ii) 5. Suppose speculators lost confidence in foreign economies and bought more U.S. bonds. How would this affect net exports in the U.S., and which way would this cause the aggregate demand curve to shift?

Q6) Describe the proc

Answer 1

Q.5. i. A favourable supply shock is a sudden increase in supply that makes the short-run aggregate supply curve (SRAS) to shift to the right, average price levels to go down and real GDP also shifts to right. In this case average price levels go down as shown in figure below from p1 to p2 a SRAS shifts right. This may make create deflation in an economy and discourage new producers to enter in the market, to bring back inflation, central bank may reduce interest rates and decrease money supply in the market in short will follow expansionary monetary policy. This will make people demand more and hence as aggregate demand shifts to right average price levels may again go up. This move will create new jobs in the market as aggregate demand will increase in short term.

ii. When speculators buy more US dollar bonds then it will increase demand for dollars and US currency(dollar) will appreciate and it will make exports from USA more expensive , as USA exports go down aggregate demand curve will shift to left in USA in short term.