Question

Consider the impact of a temporary adverse supply shock on the economy. The shock is most likely to affect the

A. LM curve

B. AD curve

C. IS curve

D. FE curve

In the short run, before general equilibrium is restores, the FE line shifts _________ and causes _________

A. right; no change in output or the real interest rate

B. right; output to rise and the real interest rate to decline

C left; no change in output or the real interest rate

D left; output to decline and the real interest rate to rise

After general equilibrium is restored, output is _____ and the real interest rate is ___ (Compare with the situation before the shock)

A. higher; higher

B. lower; higher

C. lower; lower

D. higher; higher

Answer 1

Consider the impact of a temporary adverse supply shock on the economy. The shock is most likely to affect the FE line

Explanation: The supply shock reduces the marginal productivity of labor, hence labor demand. The equilibrium real wage and employment fall due to lower labor demand. Lower employment and lower productivity both reduce the equilibrium level of output, thus shifting the FE line to the left.

In the short run, before general equilibrium is restores, the FE line shifts to the left and causes output to decline and the real interest rate to rise

After general equilibrium is restored, output is lower and the real interest rate is higher (Compare with the situation before the shock)