Assume equilibrium real GDP per year is equal to full-employment real GDP. If aggregate demand falls, then
A) the price level will increase in the short run and decrease in the long run.
B) there will be an expansionary gap.
C) there will be a recessionary gap.
D) long-run aggregate supply will eventually decrease too.

Question

Quizplus · Accepted Answer

When aggregate demand falls, it creates a recessionary gap, which means that equilibrium output is now below full employment output. This results in higher unemployment and reduced economic growth. In the long run, however, workers and firms adjust their expectations and wages, causing a leftward shift in the short-run aggregate supply curve and eventually bringing the economy back to full employment equilibrium. Therefore, there is no reason to expect long-run aggregate supply to decrease as a result of a fall in aggregate demand. Finally, option A is incorrect because the price level would actually decrease in the short run due to decreased demand.

Assume Equilibrium Real GDP Per Year Is Equal to Full-Employment