Suppose, instead of waiting for the economy described in given Problem to return to long-run equilibrium, the central bank opted to use the positive supply shock as an opportunity to move to a lower inflation target. Illustrate the impact of this change in the inflation target using an aggregate demand-aggregate supply diagram. Compare this with a graph of a situation where the central bank lowers its inflation target in the absence of a positive supply shock.
Problem
How would a shock that reduces production costs in the economy (a positive supply shock) affect equilibrium output and inflation in both the short run and the long run? Illustrate your answer using the aggregate demand-aggregate supply framework. You should assume that the shock does not affect the potential output of the economy.