Based on the given figure, the economy is initially in long-run equilibrium at point A. If there is a favorable supply shock that increases 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

Based on the given figure, the economy is initially in long-run equilibrium at point A. If there is a favorable supply shock that increases 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 increase in potential output creates a recessionary gap in the short run as the economy is still at point A. As inflation falls, the short-run aggregate supply line shifts downward from SRAS to shift to SRAS" and a new long-run equilibrium is reached at point E. The long run result of an increase in potential output is a permanent increase in output and a lower inflation rate.

Based on the Given Figure, the Economy Is Initially in Long-Run