Suppose the economy is initially in long-run equilibrium and then it experiences a supply shock in the form of sharply higher energy prices. Which of the following is true?
A) The short-run aggregate supply curve shifts leftward and the long-run supply curve shifts rightward.
B) The short-run aggregate supply curve shifts rightward and there is a movement along the aggregate demand curve.
C) The short-run aggregate supply curve does not shift and the long-run aggregate supply curve shifts rightward.
D) The short-run aggregate supply curve shifts rightward but the long-run aggregate supply curve does not shift.
E) The short-run aggregate supply curve shifts leftward and there is a movement along the aggregate demand curve.

Question

Quizplus · Accepted Answer

When there is a supply shock in the form of sharply higher energy prices, the cost of production for firms increase. This leads to a decrease in short-run aggregate supply (SRAS) as firms are not able to produce as much output at the same price level as before. This causes a leftward shift of the SRAS curve. As a result, there is a movement along the aggregate demand (AD) curve as prices rise and output falls in the short run.

However, in the long run, firms have time to adjust their production methods and find ways to become more efficient. As a result, the long-run aggregate supply (LRAS) curve shifts rightward as the economy adjusts to the new higher energy prices. But in the short run, we observe a leftward shift in the SRAS curve and a movement along the AD curve, leading to higher prices and lower output. Thus, the correct answer is E.

Suppose the Economy Is Initially in Long-Run Equilibrium and Then