An economy is currently in a state of equilibrium, at full employment. If a sudden supply shock were to decrease aggregate supply, which of the following effects will occur in the short run?
I. Real interest rates will increase.
II. Prices will rise.
III. Aggregate demand will remain unaffected.
IV. The SRAS will shift to the left.
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A. B. C. D.D
The decrease in the aggregate supply curve will be represented by a movement of the short-run supply curve to the left. In the short run, this will cause an increase in prices since the demand curve does not move. Aggregate demand will fall, unemployment will rise above the natural rate and aggregate output will fall.
The total disposable income in the economy will decrease and consumers will liquidate part of their savings to maintain stable consumption. This will decrease the supply of loanable funds, raising interest rates in the short run.