Suppose the economy is initially operating at its long run equilibrium. In the absence of stabilization policy,a sudden sharp reduction in exports due to recession overseas would cause
A) an inward shift of aggregate supply, followed by a slow outward shift of aggregate demand
B) an inward shift of aggregate demand, followed by an inward shift of aggregate supply
C) an outward shift of aggregate demand, followed by a slow inward shift of aggregate supply
D) a recession accompanied by inflation
E) a relatively short recession followed by a long, slow recovery

Question

Quizplus · Accepted Answer

A sudden sharp reduction in exports due to a recession overseas would initially reduce aggregate demand, leading to a recession. Over time, the economy would adjust and recover, albeit slowly, making option E the correct choice. This scenario does not directly imply shifts in aggregate supply as the primary initial effect, nor does it suggest an immediate combination of recession and inflation (stagflation), which would be more directly caused by supply shocks.

Suppose the Economy Is Initially Operating at Its Long Run