Refer to the above diagram.The initial aggregate demand curve is AD₁ and the initial aggregate supply curve is AS₁.If government offsets the decline in real output resulting from short-run cost-push inflation by increasing aggregate demand from AD₁ to AD₂: A)real output will rise above Q_f. B)the price level will rise from P₁ to P₂. C)it is possible that aggregate supply will shift rightward from AS₂ because nominal wage demands will rise. D)the price level will rise from P₂ to P₃.

Question

Quizplus · Accepted Answer

When the aggregate demand increases from AD₁ to AD₂, the price level will rise since there is short-run cost-push inflation. Therefore, the initial price level P₁ will rise to P₂. As a result, the new equilibrium point will be at the intersection of the new aggregate demand curve AD₂ and the initial aggregate supply curve AS₁, denoted by Q12U1B0. However, it is not possible for aggregate supply to shift rightward due to nominal wage demands rising as this would cause cost-push inflation and shift the aggregate supply curve leftward.

Refer to the Above Diagram