Suppose the economy is in a long-run equilibrium.The AS curve now shifts upward due to a one-time increase in the price of raw materials.If the central bank validates this supply shock,

Question

Quizplus · Accepted Answer

Validating the supply shock means that the central bank will increase the money supply to keep the interest rate constant. This increase in money supply will cause an upward shift in the aggregate demand curve, resulting in a higher price level. However, there will not be a recessionary gap because the central bank is taking actions to maintain aggregate demand. Option A and B are incorrect because there will not be further inflation nor will the AS curve shift upward again. Option D and E are incorrect because no recessionary gap will be created.

Suppose the Economy Is in a Long-Run Equilibrium