Suppose that the aggregate demand (ADI)curve in an economy is Y = 20,000 - 20,000
,current inflation ( )equals 0.04 (4%),and potential output (Y*)equals 19,200.If,starting from long-run equilibrium,an inflation shock raises inflation to 6%,in the short run,output will equal ________ and,in the long run,output will equal _________
A) 18,800;18,800
B) 18,800;19,200
C) 19,200;18,800
D) 19,200;19,200
E) 19,600;19,200

Question

Suppose that the aggregate demand (ADI)curve in an economy is Y = 20,000 - 20,000 
,current inflation  ( )equals 0.04 (4%),and potential output (Y*)equals 19,200.If,starting from long-run equilibrium,an inflation shock raises inflation to 6%,in the short run,output will equal ________ and,in the long run,output will equal _________
A) 18,800;18,800 
B) 18,800;19,200 
C) 19,200;18,800 
D) 19,200;19,200 
E) 19,600;19,200

Quizplus · Accepted Answer

Starting from long-run equilibrium, an increase in inflation to 6% will cause a temporary increase in output, given by the following formula:
Y = Y* + (1/1-b) * (π - π*) * Y*
where b is the slope of the ADI curve and π* is the initial inflation rate.
Substituting values in the formula:
Y = 19,200 + (1/1-0.2) * (0.06 - 0.04) * 19,200
Y = 18,800
In the long run, output will return to its potential level of 19,200, as the ADI curve shifts back to its original position, given that there are no permanent changes in the economy. Therefore, the long-run output is also 19,200.

Suppose That the Aggregate Demand (ADI)curve in an Economy Is