In the given figure, the economy is initially in long-run equilibrium at point A. If there is an adverse supply shock that reduces potential output and shifts the long-run aggregate supply curve from LRAS to LRAS', then there is initially ________ gap and the short-run aggregate supply curve will ________.
A)an expansionary; eventually shift to SRAS'
B)an expansionary; eventually shift to SRAS"
C)a recessionary; eventually shift to SRAS"
D)a recessionary; eventually shift to SRAS'

Question

In the given figure, the economy is initially in long-run equilibrium at point A. If there is an adverse supply shock that reduces potential output and shifts the long-run aggregate supply curve from LRAS to LRAS', then there is initially ________ gap and the short-run aggregate supply curve will ________. 
A)an expansionary; eventually shift to SRAS' 
B)an expansionary; eventually shift to SRAS" 
C)a recessionary; eventually shift to SRAS" 
D)a recessionary; eventually shift to SRAS'

Quizplus · Accepted Answer

The decline in potential output creates an expansionary gap in the short run as the economy is still at point A. As inflation rises, the short-run aggregate supply line shifts upward from SRAS to SRAS' and a new long run equilibrium is reached at point C. The long run result of a fall in potential output is a permanent decline in output and a higher inflation rate.

In the Given Figure, the Economy Is Initially in Long-Run