Question 

Consider the following simple macro model:

AS: P = a_o + bY

Where a_o, b, c, d > 0 and a_o < c.
a) Calculate the equilibrium values of output and the price level, Y and P.

Now suppose that a negative aggregate supply shock occurs, shifting the AS curve to,

AS: P = a₁ + bY

where 0 <  a_o < a₁.

b) Compute the new macro equilibrium under the assumption that the central bank does not respond to this shock.

c) Explain how the central bank could choose to validate this shock. Alter the AD curve to build this "validation" into the model and compute the new macro equilibrium.

d) Describe the benefits and risks of validating a negative supply shock.