Suppose the economy is initially in long-run equilibrium. Then suppose there is a drought that destroys much of the wheat crop. According to the model of aggregate demand and aggregate supply, what happens to prices and output in the short run?
A) Prices rise; output falls.
B) Prices fall; output rises.
C) Prices rise; output rises.
D) Prices fall; output falls.

Question

Quizplus · Accepted Answer

The drought would shift the short-run aggregate supply curve to the left, causing both prices and output to increase in the short run. This is because the decrease in wheat supply would increase the cost of production for firms, causing them to increase their prices and reduce their output. In the long run, however, the economy would return to its initial equilibrium with higher prices but the same level of output.

Suppose the Economy Is Initially in Long-Run Equilibrium