1. Supply Shocks
AS/AD Model Analysis

2. 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 ↑

3. Sudden rise in input prices
Stagflation ( )
Sudden rise in input prices

4. 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

5. 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