In the short run, a negative supply shock such as a sudden rise in oil prices will have what effect on the aggregate supply curve and the macroeconomic equilibrium?

Introduction / Context:
Negative supply shocks are important in macroeconomics because they can generate a combination of higher inflation and lower output, often called stagflation. Examples include sharp increases in oil prices, natural disasters that disrupt production, or sudden increases in the cost of key imported inputs. This question asks how such a negative supply shock affects the position of the short run aggregate supply curve and the resulting macroeconomic equilibrium in terms of price level and output.

Given Data / Assumptions:

• The starting point is an economy in short run macroeconomic equilibrium where aggregate demand intersects short run aggregate supply.
• A negative supply shock raises production costs for many firms at each level of output.
• Aggregate demand is assumed unchanged while the shock takes place.
• We are asked about the direction of shift in the aggregate supply curve and the effect on price level and output.

Concept / Approach:
The short run aggregate supply curve relates the quantity of real GDP supplied to the overall price level, given expected prices and nominal wages. When a negative supply shock occurs, such as a sudden rise in oil prices or key imported raw materials, production becomes more expensive at every level of output. Firms respond by reducing the quantity they are willing to supply at each price level. Graphically, this is shown as a leftward shift of the short run aggregate supply curve. With aggregate demand unchanged, the new intersection occurs at a higher price level and a lower level of real output, generating simultaneous inflation and reduced output.

Step-by-Step Solution:
Step 1: Visualise the original equilibrium where aggregate demand intersects the short run aggregate supply curve at price level P1 and output Y1.Step 2: Introduce a negative supply shock that raises production costs, such as a steep rise in global oil prices.Step 3: At every given price level, firms now find it less profitable to produce, so the quantity of output they supply falls.Step 4: This reduction in supply at each price level is represented by a leftward shift of the short run aggregate supply curve from SRAS1 to SRAS2.Step 5: The new intersection of aggregate demand and SRAS2 occurs at a higher price level P2 and lower output Y2, with Y2 less than Y1 and P2 greater than P1.Step 6: Therefore, the correct description is that the short run aggregate supply curve shifts to the left, leading to higher prices and lower output.

Verification / Alternative check:
Historical episodes such as the oil crises of the 1970s showed economies experiencing rising inflation at the same time as rising unemployment and slower growth. This phenomenon is consistent with a leftward shift of short run aggregate supply, not with a rightward shift or pure demand side shock. In simple aggregate demand and supply diagrams, drawing a leftward shift of SRAS with unchanged aggregate demand always produces a new equilibrium with higher price level and lower real GDP, supporting the analysis given here.

Why Other Options Are Wrong:
Option B states that unemployment falls and supply shifts right, which would happen with a positive supply shock, not a negative one. Option C also describes a rightward shift of aggregate supply and lower prices, again inconsistent with the idea of a negative cost shock. Option D claims the price level falls and output rises along an unchanged supply curve, which would correspond to a favourable demand shift, not an adverse supply shock. Option E suggests no change in supply or demand, which contradicts the definition of a shock itself.

Common Pitfalls:
A frequent error is to associate any unpleasant macroeconomic outcome, such as rising prices, only with shifts in aggregate demand and to forget that adverse supply shocks can also raise prices. Another pitfall is to think that higher production costs automatically reduce both prices and output, ignoring the interaction with aggregate demand. To avoid confusion, always remember that negative supply shocks shift short run aggregate supply to the left, leading to stagflation type outcomes unless aggregate demand is adjusted by policy responses.

Final Answer:
In the short run, a negative supply shock causes the short run aggregate supply curve to shift to the left, leading to higher prices and lower output.