Increases in aggregate demand are likely to create
A) deflation during recessions
B) inflation when the output gap is quite negative
C) higher output when the output gap is negative, and inflation when output is at capacity
D) reductions in output if the output gap is already positive
E) both inflation and recession

Question

Quizplus · Accepted Answer

Increases in aggregate demand can lead to higher output when the economy is operating below its full capacity (negative output gap), as increased demand leads to increased production and hiring of workers. However, as output approaches full capacity, further increases in demand can lead to inflationary pressures as firms and workers have less spare capacity to meet the increased demand. Therefore, option C is the best choice as it highlights the potential for higher output and inflation depending on the level of the output gap.

Increases in Aggregate Demand Are Likely to Create