In the short run, any fall in EP/P*, regardless of its causes, will cause
A) an upward shift in the aggregate demand function and an expansion of output.
B) an upward shift in the aggregate demand function and a reduction in output.
C) a downward shift in the aggregate demand function and an expansion of output.
D) an downward shift in the aggregate demand function and a reduction in output.
E) an upward shift in the aggregate demand function but leaves output intact.

Question

Quizplus · Accepted Answer

A fall in EP/P* implies a depreciation of the domestic currency, which leads to an increase in the price of imported goods and a decrease in the price of domestic goods. This results in a fall in net exports and a decline in aggregate demand. Therefore, there will be a downward shift in the aggregate demand function, which results in a reduction of output.

In the Short Run, Any Fall in EP/P*, Regardless of Its