Use the following to answer questions . Exhibit: Aggregate Demand Shifts and Expectations -(Exhibit: Aggregate Demand Shifts and Expectations) Suppose the economy was operating at point e in period 1. Expansionary fiscal and monetary policies adopted in period 1 resulted in a movement to point g in period 3. What happens when workers and firms become aware of a rise in the general price to P_g? A) Workers will agree to take wage cuts and firms will agree to lower prices to ward off inflation. B) They will revise their expectations of future prices to incorporate the higher price level. C) Firms with sticky prices will ultimately adjust their prices downward. D) Firms and workers will agree to renegotiate wage contracts downward.

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When workers and firms become aware of a rise in the general price level, they will revise their expectations of future prices to incorporate the higher price level. This means that they will expect prices to continue rising in the future, which could lead to a further increase in inflation. Option A is unlikely as workers are generally not willing to accept wage cuts, and firms may not lower prices if they have already increased due to the higher demand from expansionary policies. Option C may happen over time as firms adjust their prices downward but it's not a immediate action. Option D is unlikely to happen as firms and workers may not be willing to renegotiate wage contracts downward if they expect inflation to continue rising.

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