Question

Assume that an economy is currently in long-run equilibrium and the short-run aggregate supply curve is upward sloping. An adverse supply shock will most likely cause which of the following in the economy in the short run?

A) Decrease in price level, decrease in nominal wage
B) Decrease in price level, increase in nominal wage
C) Increase in price level, increase in nominal wage
D) Increase in price level, increase in real wage
E) increase in price level, decrease in real wage

Answer 1

An adverse supply shock in the short run will likely result in an increase in price level and an increase in nominal wage.

Step-by-step explanation:

When an economy is currently in long-run equilibrium and experiences an adverse supply shock, the most likely outcome in the short run is an increase in price level and an increase in nominal wage.

This is because the supply shock disrupts the economy's production capacity and increases costs, leading to higher prices and wages. However, it is important to note that in the long run, when wages and prices are flexible, the level of output returns to potential GDP and determines real GDP's size.