There is a temporary demand shock . In the short run, immediately following this shock, output and inflation are given by:

Question

There is a temporary demand shock .  In the short run, immediately following this shock, output and inflation are given by:

BlackTom AI · Accepted Answer

The question asks about the short-run effects on output and inflation immediately after a temporary demand shock.
Option analyzed: Y=0.975,π=−0.005
First, interpret the numbers: Y=0.975 indicates output is 2.5% below the baseline (a negative output gap). π=−0.005 indicates inflation is negative, i.e., a deflation of 0.5%. These signs are consistent with a sudden drop in demand where aggregate demand weakens and prices adjust downward or slowly, producing lower output and lower (possibly negative) inflation in the short run.
In many macro models with sticky prices or wage frictions, a temporary demand shock lowers real activity and reduces inflation pressures in the near term. Firms face softer demand, may reduce prices or postpone price increases, and production falls until demand recovers. This aligns with the intuition that a demand shock depresses both output and the price level in the short run.
Limitations to consider: since the problem statement provides only one option and no alternative choices to compare, we cannot contrast this result with other possible short-run paths (e.g., a scenario where inflation is unchanged or higher, or where output falls but inflation rises due to supply-side constraints). Also, the exact magnitudes (2.5% output gap and 0.5% deflation) depend on the model specifics, such as the degree of price rigidity, the responsiveness of inflation to demand, and the monetary reaction function.
In sum, viewed through the lens of a temporary demand shock in the short run, a negative output gap accompanied by deflation (Y<1, π<0) is a plausible outcome, and the given numbers reflect that intuitive story.

ECON10003_2025_SM1 Pre-Tutorial Quiz 6

There is a temporary demand shock . In the short run, immediately following this shock, output and inflation are given by:

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