Expansionary Shocks Assignment Help | Expansionary Shocks Homework Help

Expansionary Shocks

An expansionary demand shock disturbs the equality of output (GDP) and price level. The process of adjustment finally restores equality of actual GDP and potential GDP but at a higher price level, as shown.

 In both the parts (i) and (ii) of E0 is the initial equilibrium point, where AD0 curve intersect SRAS0 curve. The actual level of GDP equals the potential level Y* at the price level P0. Now, additional investment spending causes a demand shock and the AD1 curve in part (i) shifts upwards to AD1. This cases increase in both GDP and the price level. At the new equilibrium point E1 in both the parts (i) and  (ii) the new and higher level of GDP is Y1 and the price level also rises to P1.

Since actual GDP (Y1) is more than potential GDP (Y*). It opens inflationary gap shown by arrow in part (i). Inflationary gap (Y1-Y*) results into increase in the input costs, including the cost of labour, shifting the SRAS0 curve leftwards to SRAS1, as shown in part (ii). New equilibrium point is E2 where AD1 intersects the new aggregate supply curve SRAS0. At point E2 inflationary gap is eliminated as shown by arrow in part (ii) and actual GDP again becomes equal to potential GDP, but at a higher price level P2.

 For more help in Expansionary Shocks click the button below to submit your homework assignment