Suppose that a shock causes the aggregate demand curve to shift rightward. If the Fed does nothing,
A) the short- run aggregate supply curve will not shift leftward and there will be continued inflation.
B) output initially will exceed potential GDP, but the economy will return to potential GDP with a higher price level.
C) eventually the short- run aggregate supply curve will shift leftward and there will be continued inflation.
D) the economy will experience a temporary reduction in employment but will eventually return to full employment.

Question

Quizplus · Accepted Answer

Without any action from the Fed, the increase in aggregate demand will cause output to initially exceed potential GDP, leading to an increase in the price level. However, eventually, as the economy approaches full employment, the short-run aggregate supply curve will shift upward, leading to a higher price level but a return to potential GDP. This is known as the self-correcting mechanism in the long run. There would not necessarily be continued inflation or a temporary reduction in employment.

Suppose That a Shock Causes the Aggregate Demand Curve to Shift