If GDP exceeds its full-employment level in the short run, what will take place to restore general equilibrium?
A)Price level will rise, causing LM to shift upward.
B)Price level will rise, causing LM to shift downward.
C)Price level will fall, causing LM to shift upward.
D)Price level will fall, causing LM to shift downward.

Question

Quizplus · Accepted Answer

When GDP exceeds its full-employment level in the short run, it indicates an overheating economy where demand outstrips supply, leading to upward pressure on prices. As the price level rises, the real money supply decreases (since the nominal money supply is fixed in the short run), making money more expensive and thus increasing interest rates. This is represented by an upward shift in the LM curve in the IS-LM model, as higher interest rates will eventually reduce investment and consumption, bringing GDP back to its full-employment level.

If GDP Exceeds Its Full-Employment Level in the Short Run