Figure 5.7: Multi-Panel Diagram of a Negative Supply Shock's Immediate Impact
This three-panel diagram illustrates the immediate economic consequences of a negative supply shock, such as an oil price increase.
- WS-PS Diagram (Top Panel): This panel shows the labor market (real wage vs. employment). The shock shifts the price-setting curve down, for example from a real wage of 100 to 98. The economy moves from the initial supply-side equilibrium at point A on the 'PS curve (initial oil prices)' to point B on the 'PS curve (new oil price)'. This occurs at the same employment level (), opening a 2% positive bargaining gap.
- Phillips Curve Diagram (Middle Panel): This panel shows the relationship between inflation and employment. The downward shift of the PS curve causes the Phillips curve to shift upward. The economy jumps from point A on the original Phillips curve (with 2% expected inflation) to point B on the new, higher Phillips curve. At the same employment level (), inflation immediately increases from 2% to 4%.
- Multiplier Diagram (Bottom Panel): This panel shows aggregate demand and output. It is assumed that aggregate demand (AD) remains unchanged immediately after the shock. Therefore, the economy's output level remains at the initial supply-side equilibrium, , corresponding to points A and B.
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Ch.5 Macroeconomic policy: Inflation and unemployment - The Economy 2.0 Macroeconomics @ CORE Econ
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The Accelerating Wage-Price Spiral
Profit-Push Inflation (Sellers' Inflation)
Immediate Stagflationary Outcome of a Negative Supply Shock
Dual Challenge of Higher Inflation and Unemployment from a Persistent Supply Shock
Consider an economy where, following a sudden and significant increase in the price of an essential imported production input, policymakers initially do not intervene and the overall level of employment remains unchanged. Which statement best analyzes the immediate impact of this event on the economy?
An economy that heavily relies on imported oil experiences a sudden and sustained increase in global oil prices. Assuming the overall level of employment in the economy does not change in the short term, arrange the following events in the correct logical order to show how this shock leads to higher inflation.
Analyzing an Inflationary Shock
The Role of the Bargaining Gap in Inflation
In an economy where the level of employment is held constant, a sudden and significant increase in the price of a key imported raw material will cause the Phillips curve to shift downward, indicating lower inflation at the current employment level.
Following a sudden, sharp increase in the price of a key imported production input, an economy experiences inflationary pressure. Match each component of this economic process with its correct description.
Explaining the Inflationary Impact of a Supply-Side Shock
The term 'cost-push inflation' is used to describe the price increases following a negative supply shock (e.g., a rise in oil prices) because the shock directly impacts firms' production costs. In the standard macroeconomic model that explains this phenomenon, the initial impact is represented by a downward shift of the ______.
An economy experiences a significant increase in its overall inflation rate. An economist claims this is a classic case of cost-push inflation originating from a negative supply shock. Which of the following pieces of evidence would provide the strongest support for this specific claim, as opposed to other potential causes of inflation?
An economy experiences a sudden, sharp increase in its inflation rate. During this period, the national unemployment rate remains stable, and data shows that, on average, corporate profit margins have decreased. Two economists are debating the cause. Economist A argues it's due to excessive consumer spending. Economist B argues it's due to a recent global event that raised the price of essential imported industrial components. Based on the provided evidence, which economist's explanation is more plausible, and why?
Figure 5.7: Multi-Panel Diagram of a Negative Supply Shock's Immediate Impact
Origin of the Policy Dilemma from a Negative Supply Shock
Figure 5.7: Multi-Panel Diagram of a Negative Supply Shock's Immediate Impact
A central bank is preparing to analyze the potential impact of a global economic shock. To establish a clear baseline, they need to identify an initial economic state characterized by both internal (labor market) stability and price stability. Which of the following scenarios describes this ideal initial equilibrium?
Evaluating an Economy's Initial State
Defining the Ideal Economic Baseline
An economy is considered to be in an ideal initial state for policy analysis if its labor market is in equilibrium, even if the current inflation rate is higher than the central bank's target.
Match each economic scenario to the description that best characterizes its stability as an initial state for policy analysis.