A short-run equilibrium with a recessionary gap implies that
A) firms will raise the prices of their goods and services more than needed to fully cover their increases in costs.
B) firms will raise the prices of their goods and services as much as needed to fully cover their increases in costs.
C) there will be negative inflation.
D) firms have incentives to lower the relative prices of their goods and services.
E) firms have incentives to raise the relative prices of their goods and services.

Question

Quizplus · Accepted Answer

In a short-run equilibrium with a recessionary gap, there is a deficiency in aggregate demand relative to the full employment level of output. As a result, firms have excess capacity and are producing below their potential level. Since there is less demand for goods and services, firms have incentives to lower the relative prices of their goods and services to increase sales and utilize their excess capacity. Therefore, D is the correct answer.

A Short-Run Equilibrium with a Recessionary Gap Implies That