Refer to the accompanying figure. Starting from long-run equilibrium at point C, an adverse inflation shock that increases inflation from π to π¹ will lead to a short-run equilibrium at point ________ and eventually to a long-run equilibrium at point ________, if left to self-correcting tendencies.
A)A; B
B)A; C
C)B; A
D)B; C

Question

Refer to the accompanying figure.  Starting from long-run equilibrium at point C, an adverse inflation shock that increases inflation from π to π¹ will lead to a short-run equilibrium at point ________ and eventually to a long-run equilibrium at point ________, if left to self-correcting tendencies.
A)A; B 
B)A; C 
C)B; A 
D)B; C

Quizplus · Accepted Answer

An adverse inflation shock is modeled as an upward shift of the SRAS curve. In the short run, this results in higher inflation and lower output at point A. As a result of this recessionary gap, inflation will gradually start to decrease again shifting the SRAS line back down. When inflation has fallen enough, the economy is back in long-run equilibrium at C again.

Refer to the Accompanying Figure