833 $
© 2014 Pearson Canada Inc.$38 ) Describe discretionary and nondiscretionary policy in the case of a negative aggregate supply
shock to the economy. Use a graph to support your answer.
Answer: When the economy moves from point 1 to 1' after a supply shock then policymakers
have two choices: The nondiscretionary policy of doing nothing and letting the aggregate supply
curve to move back to the original position, or the discretionary policy and try to shift the
aggregate demand curve to move the economy to point 2.
Case for a discretionary policy: if the wages and prices adjust extremely slow a nondiscretionary
policy is considered by an advocate for discretionarys as costly because the slow movement of
the economy back to full employment results in a large loss of output.
Case for a nondiscretionary policy: advocates for nondiscretionary policy view the wage and
price adjustment process as more rapid than advocates for discretionary do and consider
nondiscretionary policy less costly because output is soon back at the natural rate level. They
suggest that an discretionary accommodating policy of shifting the aggregate demand curve to
AD2 is costly because it produces more volatility in both the price level and output.
Diff: 2 Type: SA Page Ref: 628
Skill: Recall
Objective List: 26.2 Characterize the discretionary versus nondiscretionary and rules versus
discretion policy debates