Figure 7-6 -Refer to Figure 7-6. Suppose the economy is initially at point A. Now suppose an increase in government purchases shifts the aggregate demand curve to AD₂. What happens in the new short run? A) Firms increase output because product prices rise while real wage falls. B) Firms increase output because product prices and real wage rise. C) Firms will have to pay higher nominal wages and employ more workers to supply the increased output. D) The price level increases to P_b, real wages, nominal wages, and employment increase.

Question

Quizplus · Accepted Answer

When the aggregate demand curve shifts to the right, output and prices increase in the short run. Firms will want to produce more output, leading to an increase in the demand for labor. This increase in demand for labor puts upward pressure on real wages. However, the increase in output leads to an increase in the demand for goods, which puts upward pressure on prices. Product prices rise while real wages fall. Therefore, choice A is the correct answer.

Figure 7-6 -Refer to Figure 7-6. Suppose the Economy Is Initially at Is