If there were stagflation in the economy caused by a decrease in aggregate supply:

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This question asks about stagflation in the economy arising from a decrease in aggregate supply.
First, recall that stagflation refers to a situation where inflation (higher price level) and stagnation (lower real output or GDP) occur simultaneously, typically due to negative supply shocks.
A decrease in aggregate supply shifts the short-run aggregate supply (SAS) curve to the left. When SAS shifts left, at the original price level, output falls because fewer goods and services are being produced, which reduces real GDP.
With production constrained, firms may bid up prices, or higher costs filter through to consumers, causing the overall price level to rise. Thus, the economy experiences higher inflation alongside lower real output, which is the hallmark of stagflation caused by a supply shock.
Given option evaluations:
- The described outcome—real output falling and the price level rising—aligns with the standard analysis of a negative supply shock leading to stagflation.
- If there were alternative options proposing, for example, that only prices rise with no change in output, or that output rises while prices fall, those would contradict the core effect of a leftward SAS shift and would not reflect stagflation.
- Any explanation attributing stagflation solely to demand-side factors or asserting that aggregate supply changes cannot influence price levels would miss the fundamental mechanism: a decrease in supply raises price levels while reducing output.

In summary, the key mechanism is that a negative supply shock reduces aggregate supply, causing higher price levels and lower real output, which is the defining feature of stagflation in this context.

ECON1002 Introductory Macroeconomics

If there were stagflation in the economy caused by a decrease in aggregate supply:

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