Within the AD/AS model, which one of the following adjustments will cause the economy to return to its long-run capacity when output is temporarily greater than the economy's long-run potential?
A) Lower wage rates and resource prices reduce short-run aggregate supply.
B) Lower interest rates increase aggregate demand and, thereby, stimulate output.
C) Higher wage rates and resource prices reduce short-run aggregate supply.
D) A decrease in prices reduces aggregate demand.

Question

Quizplus · Accepted Answer

When output is temporarily greater than the economy's long-run potential, the economy is in a state of inflation, which is unsustainable in the long run. Therefore, to return to the long-run capacity or potential, the short-run aggregate supply needs to be reduced. A reduction in short-run aggregate supply can be achieved by increasing the wage rates and resource prices, which will make production more expensive and limit the amount of output that can be achieved. Therefore, choice C is the correct answer. Choices A and B could actually increase output and prolong the inflationary period, while choice D would only decrease output without addressing the root cause of the inflation.

Within the AD/AS Model, Which One of the Following Adjustments