Consider an economy that begins with real GDP equal to potential. There is then a sudden increase in the price of raw materials.
Draw the initial long-run equilibrium in an AD/AS diagram.
Is there unemployment at long-run equilibrium? Explain.
Now show the immediate effect of the increase in the price of raw materials.
Suppose wages and prices in this economy adjust instantly to shocks. Describe what happens to unemployment in this economy. Explain.
If wages and prices adjust slowly to shocks, what happens to unemployment? Explain.
Suggest an action the government can take to fix the problem in (E)