Shocks and Fiscal Policy

Question 1

Define “Shocks”

Answer 1

A situation in which firms/businesses were expecting one thing to happen but something else happened

Question 2

What are the 3 elements to the aggregate demand / aggregate supply curve?

Answer 2

1. AD curve which is downward sloping and shows how the short-run equilibrium output depends on PL/ inflation. 2. Short Run Aggregate Supply Curve (SRAS) Horizontal line showing price level or inflation.
2. Long Run Aggregate Supply Curve (LRAS) Vertical line showing potential out put Y*

Question 3

Define Short Run Equilibrium Output

Answer 3

Where AD crosses SRAS

Question 4

What are the three sources of inflation?

Answer 4

1. The presence of an output gap 2. Inflation Shocks 3. Aggregate Supply Shocks

Question 5

What happens to inflation during output gaps?

Answer 5

inflation tends to rise when there is an expansionary output gap and to fall when there is a recessionary output gap

Question 6

Define Inflation Shocks

Answer 6

A temporary but sudden change in the normal behavior of inflation, unrelated to output gaps directly affecting prices. Creation of stagflation

Question 7

Define Aggregate Supply Shocks

Answer 7

A permanent reduction in potential output, with output not recovering following a shock to potential output. A sharp change in the level of potential output.