In the AS/AD framework, the financial friction appears as a:
A) negative demand shock.
B) negative supply shock.
C) change in the long-run real interest rate.
D) positive supply shock.
E) The financial friction is only present in the IS/MP model.

Question

Quizplus · Accepted Answer

Financial frictions, such as increased difficulty in obtaining loans or a rise in interest rates, typically reduce spending and investment. This leads to a decrease in aggregate demand, hence it is considered a negative demand shock in the AS/AD framework.

In the AS/AD Framework, the Financial Friction Appears as A