Refer to the graph above. Assume that the economy is in initial equilibrium where AD₁ intersects AS₁. If there is an unanticipated increase in aggregate demand and the economy self-corrects, then the adaptive-expectations adjustment path would go from point: A) A directly to B B) A to B to C C) B to A to D D) A to B to C to D

Question

Quizplus · Accepted Answer

In the case of an unanticipated increase in aggregate demand, the economy will initially move along AD1 to a new short-run equilibrium at point B, where output increases and prices rise. However, in the long run, firms will adjust their prices and the SAS curve will shift to the left, bringing the economy back to potential GDP at point C. The adaptive-expectations adjustment path would therefore show a gradual movement from point A to B as output and prices adjust in the short run, followed by a shift back to point C as the SAS curve adjusts in the long run. Therefore, the correct choice is B, as it reflects the movement from A to B and then to C.

Refer to the Graph Above