Chapter 13, Problem 1FT

To determine

Distinguish between aggregate demand shocks and real shocks.

Answer to Problem 1FT

Table 1 shows the classification of different economic events as aggregate demand shocks and real shocks.

Table 1

Aggregate demand shocks	Real shocks
A rise in consumer optimism	A fall in price of oil
A rise in sales taxes	A hurricane that destroys factories in Florida
Foreigners watching fewer US-made movies	Good weather that creates a tremendous increase in the growth of oranges in California.
Fear	New inventions occur at a faster pace than usual
A faster money growth rate

Explanation of Solution

The aggregate demand shock is an immediate change in the demand for goods or services. The rise in consumer optimism increases the confidence about the price of a commodity and changes the demand for that commodity. In case of rise in sale, the tax also suddenly changes the demand for that taxed commodity. If the foreigners watch fewer US-made movies, then it will reduce the demand of US-made movies. If the consumers dread an increase in the price of a product in future, this will change the demand for that commodity at present. The faster money growth rate increases the income of people in the economy, thereby affecting the demand for goods and services. On the basis of these characteristics, these economic events are included in the category of aggregate demand shock.

The real shock is an unexpected economic situation that affects the factors of production used in the production process. The fall in the price of oil affects its factors of production. The hurricane increases the price of factors of production. Good weather creates a tremendous increase in the growth of oranges in California. This extra-large production increases the demand for its factors of production. In the case of new inventions, they alsorise the demand factors of production.

Economics Concept Introduction

Concept introduction:

Aggregate demand shocks: An aggregate demand shock is a sudden surprise event that temporarily increases or decreases the demand for goods or services.

Real shocks: A real shock is an unexpected or unpredictable event that affects the fundamental factors of production.