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

Question

3. 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 cell 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. (8 marks) Type of shock Comments (1 mark each) Reasons (1 mark each) Positive supply shock? Negative supply shock? Positive demand shock? Negative demand shock?

Explanation / Answer

Type Of Shock Comment Reason Positive supply shock most preferred Shifts AS To right It shows reduced prices and increased supply, which increases economic growth rate and creates positive animal spirit. Unemployment decreases. Negative supply shock least preferred Shifts AS to the left. This results into stagflationary effect as prices increase but demand decreases in economy. Unemployment increases. Positive demand shock Unclear This shifts AD to right.This is good because increase in AD and increase in jobs.However, it may be inflationary also once spare capacity is over in an economy. Negative demand shock most preferred This shifts AD to left, shows decreased demand in an economy, increases unemployment.

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