Question

Aggregate supply shocks can cause _______ inflation rates that are accompanied by _______ unemployment rates.

a. higher; higher

b. higher; lower

c. lower; higher

d. lower; lower

Short answer

The correct option is (a).

Step-by-step solution

The explanation for correct option (a)

The adverse supply shock leads to a leftward shift in the short-run aggregate supply curve. As a result, the output level and the price level increase. If the output level falls below the full-employment level, the current unemployment rate rises above its natural rate.Thus, negative supply shock causes an increase in both the inflation rate and unemployment rate.

So, option (a) is correct.

The explanation for incorrect options (b), (c), and (d). 

Option b) is incorrect because if the aggregate supply curve shifts leftward, then the price level would be higher, the output level would be lower, and the unemployment rate would be higher and not lower.

The price level rises and the unemployment rate falls due to the rightward shift of the aggregate demand curve.

Option c) is incorrect because if the aggregate supply curve shifts leftward, the price level would be higher and not lower, the output level would be lower, and the unemployment rate would be higher.

The price level falls, and the unemployment rate rises due to the leftward shift of the aggregate demand curve.

Option d) is incorrect because if the aggregate supply curve shifts leftward, then the price level would be higher and not lower, the output level would be lower, and the unemployment rate would be higher and not lower. Both price level and the unemployment rate fall due to the rightward shift of the aggregate demand curve.