In the long run, inflationary and recessionary gaps are self-correcting because eventually:
A) nominal wages rise to close an inflationary gap or fall to close a recessionary gap.
B) the government applies the right combination of fiscal and monetary policies.
C) the multiplier compensates for the negative supply or demand shocks.
D) nominal wages rise to close a recessionary gap and fall to close an inflationary gap.

Question

Quizplus · Accepted Answer

Nominal wages eventually adjust to the level of output in the economy. In an inflationary gap, demand for goods and services is high, increasing the demand for labor and pushing up wages. As wages rise, production costs increase, causing a decrease in supply and increasing prices until equilibrium is reached. In a recessionary gap, demand for goods and services is low, causing a decrease in the demand for labor and pushing wages down. As wages fall, production costs decrease, causing an increase in supply and decreasing prices until equilibrium is reached.

In the Long Run, Inflationary and Recessionary Gaps Are Self-Correcting