Consider the following \(A D / A S\) diagram. Suppose the economy experiences a positive aggregate demand shock-say, an increase in the demand for Canada's exports. This increases real GDP to \(Y_{1}\).

a. Explain what happens if the Bank of Canada does not react to the shock. Show this in the diagram.

b. Now suppose the Bank decides to maintain real GDP at \(Y_{1}\)-that is, it decides to validate the shock. Explain how this is possible, and show it in a diagram.

c. What is the effect on inflation from the policy in part (b)? Is inflation constant or is it rising? Explain.

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Price Level -- AS 0 Y* Real GDP ADO -AD