Starting from a long-run equilibrium, an increase in potential output leads to ________ gap in the short run and to ________ rates of inflation in the long run.
A)an expansionary; higher
B)an expansionary; lower
C)a recessionary; lower
D)a recessionary; higher

Question

Quizplus · Accepted Answer

An increase in potential output, modeled as a rightward shift of the LRAS, creates a recessionary gap in the short run. As inflation falls, the short-run aggregate supply line shifts downward and a new long-run equilibrium is reached where actual output equals the new, higher level of potential output. The long run result of an increase in potential output is a permanent increase in output and a lower inflation rate.

Starting from a Long-Run Equilibrium, an Increase in Potential Output