If there is an unanticipated increase in aggregate demand, then according to new classical economics, the economy will self-correct with a(n):
A) Decrease in short-run aggregate supply, so output returns to its initial level, but the price level rises
B) Decrease in short-run aggregate supply, so output increases and the price level rises
C) Decrease in short-run aggregate supply, so output returns to its initial level and the price level falls
D) Increase in short-run aggregate supply, so output increases and the price level rises

Question

Quizplus · Accepted Answer

New classical economists believe in the natural rate hypothesis, meaning that in the long run, the economy will always return to its natural rate of output regardless of changes in aggregate demand. Therefore, in the short run, an increase in aggregate demand will lead to a decrease in short-run aggregate supply due to input prices being sticky in the short run. This will cause output to return to its initial level, but the price level will rise as a result.

If There Is an Unanticipated Increase in Aggregate Demand, Then