A cost shock in the economy may lead to -

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Cost shocks affect the economy by altering production costs, which can influence multiple macroeconomic indicators.

Option 1: increase in price level. When firms face higher input costs, they may raise prices to maintain profit margins, contributing to a higher overall price level or inflation in the short to medium term. This pathway is a common transmission mechanism of cost-push inflation.

Option 2: decrease in output. Higher costs can reduce aggregate supply, shifting the short-run supply curve leftward. With higher per-unit costs, firms may produce less at any given price, leading to a drop in output or real GDP in the short run.

Option 3: stagflation. If the economy experiences both rising prices (inflation) and falling output (stagnation), the combination is referred to as stagflation. A cost shock is a classic trigger for this scenario, since it simultaneously pressures prices upward and dampens real activity.

Option 4: all of the other options are correct. Given that a cost shock can plausibly cause higher price levels, reduced output, and potentially stagflation, this option logically aggregates the possible outcomes described above.

In summary, the mechanisms by which a cost shock propagates through the economy can manifest as higher inflation, lower output, and, in certain contexts, stagflation, making the bundled statement consistent with multiple observable effects.

ECON 2020-001 Spring 2025 Practice Exam (Midterm 2)

A cost shock in the economy may lead to -

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