Suppose the economy is initially in long-run equilibrium. Then suppose there is an increase in military spending due to rising international tensions. According to the model of aggregate demand and aggregate supply, what happens to prices and output in the short run?
A) Prices fall; output rises.
B) Prices fall; output falls.
C) Prices rise; output falls.
D) Prices rise; output rises.

Question

Quizplus · Accepted Answer

An increase in military spending will shift aggregate demand to the right in the short run, causing an increase in both prices and output. This is because there will be more demand for goods and services due to increased government spending, but in the short run, firms may not be able to immediately increase production to meet this demand, leading to a temporary increase in prices. In the long run, however, prices will typically adjust to eliminate any inflationary effects, returning the economy to its initial equilibrium.

Suppose the Economy Is Initially in Long-Run Equilibrium