If the economy was initially at a long-run equilibrium, the short-run effects from a decrease in aggregate demand will include:
A)a recessionary gap.
B)a decrease in potential output.
C)an increase in the current inflation rate.
D)a decrease in the target rate of inflation.

Question

Quizplus · Accepted Answer

A decrease in aggregate demand will lead to a decrease in output and employment in the short run, creating a recessionary gap where output is below potential. This will temporarily reduce inflationary pressures. However, potential output will not necessarily decrease as it is determined by factors such as technology, labor force size, and capital stock. The target rate of inflation is a policy choice and is not directly affected by changes in aggregate demand.

If the Economy Was Initially at a Long-Run Equilibrium, the Short-Run