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Asked By :  Megan
Answers1

An economy experiences a sharp increase in energy prices and po

An economy experiences a sharp increase in energy prices, and policy makers adopt a stabilization policy to increase aggregate
demand. Compared with the initial short-run equilibrium, which of the following will definitely occur?
(A) Lower level of output
(B) Higher level of output
(C) Lower price level
(D) Higher price level
(E) Higher aggregate supply



Answers :

0

The answer is (D) Higher price level.

Here's why:

  • Sharp Increase in Energy Prices: This acts as a supply shock, specifically a negative supply shock. It disrupts production and increases costs for businesses.

  • Impact on Aggregate Supply: The negative supply shock shifts the aggregate supply curve to the left, meaning producers are willing to sell less at each price level due to higher input costs (energy).

  • Stabilization Policy to Increase Aggregate Demand: This policy could involve measures like increasing government spending or lowering interest rates. The goal is to counteract the decrease in demand caused by the supply shock.

  • Short-Run Outcome: In the short run, the increase in aggregate demand might not be enough to fully offset the leftward shift in aggregate supply. This creates a disequilibrium with:

    • Higher price level: Due to the limited supply and increased demand, the price level will likely rise to a new equilibrium point.
    • Lower level of output: The higher price level might discourage some consumption, leading to a decrease in output compared to the initial equilibrium.

Long-Run Considerations:

  • In the long run, the economy might adjust to the higher energy prices through innovation, substitution of resources, or improved efficiency. This could lead to a rightward shift in the aggregate supply curve in the long run.

In conclusion, while the stabilization policy aims to increase aggregate demand, in the short run, the most likely outcome of a sharp increase in energy prices combined with a demand-boosting policy is a higher price level (D) and potentially a lower level of output.


Answered By

Keith

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