The economy starts at long-run equilibrium

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Suppose that the economy starts at a long-run equilibrium and that the short-run aggregate supply curve has a positive slope. Now suppose that a negative supply shock hits the US.

(a) No Policy Intervention: Using the model of aggregate demand and aggregate supply and the Phillips curve illustrate graphically the impact in the short run and in the long run of this negative supply shock. Be sure to label the axes, the curves, the initial equilibrium values, the direction the curves shift, the short-run equilibrium values, and the long-run equilibrium values. Explain what happens to prices and output in short run and the long run.

(b) Policy Intervention: Suppose that you are an economist working for the Treasury Department (thus, you can only use fiscal policy tools) when this negative supply shock is observed. Using the model of aggregate demand and aggregate supply and the Phillips curve illustrate graphically your policy recommendation to accommodate this adverse supply shock, assuming that your top priority is maintaining full employment in the economy. Be sure to label the axes, the curves, the initial equilibrium values, the direction the curves shift, the short-run equilibrium values, and the long-run equilibrium values. Explain what happens to prices and output in short run and the long run.

Reference no: EM131376381

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