4. Among the four economics shocks listed below, you must comment on each shock

Question

4. Among the four economics shocks listed below, you must comment on each shock by stating which shock is the most preferred and the least preferred from the point of views of the economic policy advisors. Provide reason for each comment. If unclear (ie, cannot clearly say whether more or less preferred), state unclear and explain why. To answer, fill the cells marked with? in the following table. Hints: Start from the situation where the economy is at potential output and then think about the shocks. No need to draw the AD-AS figure. Also, no need to comment on the policy reaction to each shock (that is beyond the coverage of this assignment). (8 marks)

Comments (1 mark each) Reasons (1 mark each)

1) Positive supply shock Comments? Reasons?

2) Negative supply shock Comments? Reasons?

3) Positive demand shock Comments? Reasons?

4) Negative demand shock Comments? Reasons?

Explanation / Answer

Positive supply shock is most preferred because it leads to increased output levels and reducced aggregate price level whereas negative supply shock is least prefered because it leads to both lower output which translates into lower level of employment and increased price level in the economy.

Negative and positive demand shocks are unclear because negative demand shock reduces price level but at the same time reduces level of output thus lower level of employment.. Opposite to this positive demand shock increases output level thus lowering unemployment in the economy but also increases price level.

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