Compared to an initial long-run equilibrium, an aggregate supply shock that reduces potential output results in a(n)________ gap in the short run and ________ output and ________ inflation in the long run.
A)recessionary; lower; higher
B)expansionary; lower; higher
C)expansionary; higher; higher
D)recessionary; potential; higher

Question

Quizplus · Accepted Answer

A decline in potential output, modeled as a leftward shift of the LRAS, creates an expansionary gap in the short run. As inflation rises, the short-run aggregate supply line shifts upward and a new long-run equilibrium is reached where actual output equals the new, lower level of potential output. The long run result of a fall in potential output is a permanent decline in output and a higher inflation rate.

Compared to an Initial Long-Run Equilibrium, an Aggregate Supply Shock