4. Sunspot shocks in Dynamic AD-AS Suppose that people's expectations of inflation are subject to random shocks. That is, instead of being merely adaptive, expected inflation in period t, as seen in period t 1, is Et1t = t1 + t1, where t1 is a random shock. This shock is normally zero, but it deviates from zero when some event beyond past inflation causes expected inflation to change. Similarly, Ett+1 = t + t . 2 1. Derive both the dynamic aggregate demand and the dynamic aggregate supply equation in this slightly more general model 2. Suppose the economy experiences an inflation scare. That is, in period t, for some reason people come to believe that inflation in period t + 1 is going to be higher, so t is greater than zero for this period only. What happens to aggregate demand and aggregate supply in period t? What happens to output, inflation, and nominal and real interest rates in that period? 3. What happens to aggregate demand in t + 1? What happens to output, inflation, and nominal and real interest rates in t + 1? 4. What will happen to the economy in the subsequent periods? 5. In what sense are inflation scares self-fulfilling?