Answer to Question #145139 in Economics for Youmna

Question

Assume that two shocks happen simultaneously:a positive expenditure shock and a positive supply shock (let’s say prices on imported inputs decreased dramatically due to a substantial reduction in tariffs). Use AE/PC Model (carefully labeled!!) without time lags (use the AE and PC graphs similarly to the textbook, place PC graph below AE graph).For your analysis, choose as a starting point (marked A) an economy operating at potential GDP (Y=Y*) and at its inflation target (π = π^T).show point B where the economy is situated after the shocks but prior to any central bank policy response. There should be A and B on BOTH the upper (AE graph) and lower (PC graph) graphs. If points A and B are the same point, then just mark that point with both A and B. Mark initial curves with the superscript 1, like AE1 and PC1, and every subsequent shift with a higher number, like the second shift would be AE2 and PC2, and the third shift would be AE3 and PC3 and so on. Describe that situation.

Answer 1

If two shocks happen simultaneously: a positive expenditure shock and a positive supply shock, then both AE and PC curves will shift to the right. As a result the output level will increase above the potential level, and the price level may either increase or decrease.