Question

Which one do you consider to be a worst outcome: a permanent negative supply shock or a temporary negative supply shock? Justify your selection with specific reasons, facts, and examples. In replies to peers, discuss whether you agree or disagree and justify your stance using the Topic Materials or outside resources.

Answer 1

A permanent negative supply shock is a worse outcome than a temporary supply shock.

A permanent negative supply effect the long run Aggregate supply curve and shifts it leftwards. The effect of the shift in LAS will be a lower real potential GDP of the economy and inflation. The real gdp of the economy will fall forever and price level will rise forever.

A temporary negative supply will have same impact as permanent shock, that is, an increase in inflation and reduction in real gdp but only in short run. The economy will eventually adjust to the shock and the real gdp and price level will come back to its potential GDP.

For example, a permanent decrease in labor force or depletion of a natural resource is a permanent supply shock and the potential GDP will fall as the economy will now be able to produce lesser even with optimal utilization of its resources.

On the other hand, earthquake may destroy factories which will reduce output temporarily which will increase prices in the market. But as factories are reconstructed, supply will increase and prices will adjust.

Thus, permanent negative supply shock is worse.