If the economy was initially at a long-run equilibrium, the short-run effects from a decrease in aggregate demand will include:
A)A recessionary gap
B)A decrease in potential output
C)An increase in the current inflation rate
D)A decrease in the target rate of inflation

Question

Quizplus · Accepted Answer

A decrease in aggregate demand will lead to a decrease in output and an increase in unemployment. This creates a recessionary gap, where actual output is below potential output. In the short run, this will lead to a slowdown in economic growth and increased economic instability. However, in the long run, prices will adjust downward, and the economy will return to a new long-run equilibrium with lower prices and output. There is no reason to believe that a decrease in aggregate demand will cause a decrease in potential output or an increase in the current inflation rate.

If the Economy Was Initially at a Long-Run Equilibrium, the Short-Run