Supply Shocks AS/AD Model Analysis

Supply Shocks Supply shocks are unexpected/sudden shifts in SRAS They are considered temporary situations There are both negative (adverse) & positive supply shocks SRAS ↓ SRAS ↑

Sudden rise in input prices Stagflation (1974-1977) Sudden rise in input prices

Adverse Supply Shock SRAS curve shifts left BOTH unemployment & price level rise (stagflation) considered cost push inflation Challenge: Policymakers can influence AD BUT cannot offset both simultaneously Fiscal Policy is of no help here! SRAS2 -------- P2 Y2 -------------

Economic Policy Challenge Short Run => inflation increases both R-GDP & employment Expansionary fiscal policy works! Long Run => inflation does not impact R-GDP or employment Conclusion: Fiscal Policy not helpful in the long run! should focus on shifting PPF => raise a country’s full potential! LRAS1 Price Level Real GDP SRAS1 SRAS2 AD2 --------------- P2 Y2 E2 ------------- . E2 ---------- P3 Y3 E3 AD1 E3 P1 --------- E1 Y1