Question

In response to the effects of a negative supply shock, policymakers decide to decrease aggregate demand. What are the effects of this choice?

Answer 1

Decreasing aggregate demand in response to a negative supply shock can lead to reduced spending and consumption, increased unemployment, and lower inflation.

Step-by-step explanation:

When policymakers decide to decrease aggregate demand in response to the effects of a negative supply shock, it can have several effects on the economy:

1. Reduced spending and consumption: Decreasing aggregate demand means that consumers and businesses will spend less on goods and services. This could lead to a decrease in sales and profits for businesses.
2. Increased unemployment: With reduced spending, businesses may have to lay off employees to cut costs. This can lead to higher unemployment rates and reduced income for workers.
3. Lower inflation: Decreasing aggregate demand can help reduce inflationary pressures in the economy. With less demand, businesses may not be able to raise prices as easily, which can lead to lower inflation rates.

Overall, decreasing aggregate demand can help stabilize the economy during a negative supply shock by reducing inflationary pressures and addressing the imbalance between supply and demand.