Question

If there is a negative permanent supply shock,

a.) Please explain ‘no policy response’ case.

b.) Please explain ‘policy stabilizes inflation’ case

please short answer

Answer 1

a) A negative permanent supply shock shifts the long run aggregate supply curve towards leftwords direction and the short run aggregate supply curve in upwards direction, the economy will return to the long run equilibrium with fall in output level and rise in inflation rate.

b) During the negative permanent supply shock the long run aggregate supply curve shifts leftwords, with contractionary monitory policies the demand is also reduced, the aggregate demand will move downwords and a new equilibrium is achieved with stablised inflation rate.