FIGURE 14-6
A Supply Shock A supply shock in period
t shifts the dynamic aggregate supply curve upward from
DASt–1 to
DASt. The dynamic aggregate demand curve is unchanged. The economy’s short-run equilibrium moves from point A to point B. Inflation rises and output falls. In the subsequent period (
t + 1), the dynamic aggregate supply curve shifts to
DASt+1 and the economy moves to point C. The supply shock has returned to its normal value of zero, but inflation expectations remain high. As a result, the economy returns only gradually to its initial equilibrium, point A.