Question

I am working on an assignment which asks the following as part of one question:

1. Explain the effect on income, output, employment and price level of a negative demand shock. What policies can be used to reverse this demand shock?
2. Explain the effect on income, output, employment and price level of a negative supply shock. What policies can be used to reverse this supply shock?

I'm hoping for a bit of a walkthrough of the effects of each. I have a general understanding of what the outcome is for each, and what can cause these shocks, but get lost in the 'chain of events.'

Answer 1

A) At initial equilibrium price level,there will increase in firms inventory due to negitive demand shock.To maintain same the level of inventory,firms Decreases Production ,so output Decreases.

Decrease in firms Production , Quantity supplied Decreases ,lead to decrease in price Level.

There is positive relation between output and employment.higher yhe output, higher the employment.so Decrease in output lead Decrease in employment.

B) A negative supply shock lead to left shift of aggregate supply curve.

Decrease in aggregate supply will lead to decrease in firms inventory at initial price Level.

To maintain same level of inventory,firms Increase Production,so Quantity supplied Increases and lead to increase in price level.

Increase in price level lead to decrease in Quantity demanded,so as result output Decreases and employment too.