The Economy of Macroland Is Initially in Long-Run Equilibrium

question 21

Essay

The economy of Macroland is initially in long-run equilibrium. A severe drought causes an adverse supply shock.
a. What happens to prices and output in the short run?
b. What would happen to prices and output in the long run if there is no policy accommodation?
c. If the Central Bank of Macroland wants to prevent the short-run changes in price and output, what policy action could it take? How would the results of this policy action differ from the prices and output that would result in the long run with no policy action?

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Definitions:

Selling Expenses

Costs incurred directly from the sale of a product or service, not including the cost of goods sold but may include advertising, sales commissions, and store supplies.

Absorption Costing

A pricing approach that encompasses all production expenses, such as direct materials, direct labor, along with both variable and fixed overhead, in a product's cost.

Variable Costing

An accounting method that only allocates variable costs to inventory, treating fixed costs as period costs that are expensed in the period they are incurred.

Operating Income

The profit realized from a business's operations after subtracting operating expenses from gross profit, indicating the efficiency of core business activities.