Based on the figure below. Starting from long-run equilibrium at point C, a favorable inflation shock that decreases inflation from πto π¹ will lead to a short-run equilibrium at point ___ and eventually to a long-run equilibrium at point ____, if left to self-correcting tendencies. A) A; B B) A; C C) B; A D) B; C

Question

Quizplus · Accepted Answer

A favorable inflation shock is modeled as a downward shift of the SRAS curve. In the short run, this results in lower inflation and higher output at point A. As a result of this expansionary gap, inflation will gradually start to increase again - shifting the SRAS line back up. When inflation has again risen enough, the economy is back in long-run equilibrium at C.

Based on the Figure Below