If labor costs rise at the same time that the federal government decreases its spending, in the short run
A)aggregate output and the price level will both increase.
B)aggregate output will increase, but the price level will fall.
C)aggregate output and the price level will both fall.
D)aggregate output will fall, but the price level may either increase or decrease.

Question

Quizplus · Accepted Answer

When labor costs rise, firms are faced with higher costs of production, leading to a decrease in aggregate supply. At the same time, the federal government decreasing its spending will lead to a decrease in aggregate demand. The result is a decrease in aggregate output. As for the price level, it may either increase or decrease depending on the relative strengths of the decrease in aggregate demand and the decrease in aggregate supply. However, we can be certain that both aggregate output and the price level will not increase as stated in option A, nor will the price level necessarily fall as stated in option B. Option C is incorrect because the effect on the price level is uncertain.

If Labor Costs Rise at the Same Time That the Federal