If the short-run aggregate supply curve is horizontal, and, if each member of the general public chooses to hold a larger fraction of his or her income as cash balances, then:
A) output and employment will increase in the short run.
B) output and employment will decrease in the short run.
C) prices will increase in the short run.
D) prices will decrease in the short run.

Question

Quizplus · Accepted Answer

When individuals choose to hold a larger fraction of their income as cash balances, it implies a decrease in consumption and investment spending. In the short run, with a horizontal aggregate supply curve (indicating a situation of excess capacity or slack in the economy), this reduction in spending leads to a decrease in demand for goods and services. Consequently, output and employment will decrease as businesses respond to the lower demand by reducing production and possibly laying off workers. Prices tend not to change immediately due to the horizontal nature of the supply curve, which suggests prices are sticky in the short run.

If the Short-Run Aggregate Supply Curve Is Horizontal, And, If