Suppose the economy is operating in long-run equilibrium and a positive demand shock hits. We expect a short-run increase in real GDP and the price level and a long-run _____ in real GDP and _____ the price level.
A) decrease; increase
B) increase; increase
C) decrease; decrease
D) increase; decrease

Question

Quizplus · Accepted Answer

In the short run, a positive demand shock leads to an increase in both real GDP and the price level. However, in the long run, the economy adjusts back to its potential output, meaning real GDP returns to its original level (thus, no long-term increase or decrease), but the price level remains higher due to the inflationary effects of the demand shock. Choice A correctly captures this dynamic by indicating a return to the original level of real GDP (interpreted as "decrease" from the short-run elevated level) and an increase in the price level.

Suppose the Economy Is Operating in Long-Run Equilibrium and a Positive