Using the aggregate supply and demand model, illustrate what happens in the long run when the economy suffers a supply shock. Begin your analysis by assuming the economy has suffered the supply shock in the short run, but has not yet adjusted to it in

the long run.

What will be an ideal response?

The economy is at point B with the price level equal to P2 and the amount of real GDP at Y2. The economy is at short-run equilibrium after a supply shock. Rising unemployment and falling output result in workers being willing to accept lower wages and firms being willing to accept lower prices. This will shift the SRAS curve to the right as their expectations change. This lowers the price level from P2 to P1 and raises real GDP from Y2 to Y1. Unemployment falls as real GDP rises back to potential GDP at Y1.