What is a supply shock, and why might a supply shock lead to ...

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What is a supply shock, and why might a supply shock lead to stagflation?
 
  What will be an ideal response?

Question 2

The purchase of Treasury securities by the Federal Reserve will, in general
 
  A) not change the money supply.
  B) decrease the quantity of reserves held by banks.
  C) increase the quantity of reserves held by banks.
  D) not change the quantity of reserves held by banks.

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Answer to Question 1

A supply shock is an unexpected event that causes a shift in short-run aggregate supply. An adverse supply shock causes the short-run aggregate supply curve to shift to the left, causing an increase in the price level and a decrease in real GDP. An increase in the price level occurring at the same time as a decrease in real GDP is known as stagflation.

Answer to Question 2

C