Question

If the economy is experiencing a recession due to a negative aggregate demand shock, the return to potential output

Answer 1

If the economy is experiencing a recession due to a negative aggregate demand shock, the return to potential output will be slower, the faster wages and prices adjust .

Explanation:

The economic shock of demand is an unexpected phenomenon that suddenly raises or reduces demand for goods or services. A shock of positive demand increases total demand and a shock of negative demand decreases aggregate demand. In both situations, products and services costs are impacted.

Stock shocks are somewhat different from shocks of demand. In this scenario, whether such shocks are temporary or permanent depends on the long term effect.

For example, assume that a rise in oil prices results in a negative supply shock (as a raise in input prices would result in a drop in SRAS). Having a negative supply shock, demand is declining, but inflation and unemployment are rising.