In the short run, any fall in EP /P, regardless of its causes, will cause
A) an upward shift in the aggregate demand function and an expansion of output.
B) an upward shift in the aggregate demand function and a reduction in output.
C) a downward shift in the aggregate demand function and an expansion of output.
D) an downward shift in the aggregate demand function and a reduction in output.
E) an upward shift in the aggregate demand function but leaves output intact.

Question

In the short run, any fall in EP  /P, regardless of its causes, will cause
A) an upward shift in the aggregate demand function and an expansion of output. 
B) an upward shift in the aggregate demand function and a reduction in output. 
C) a downward shift in the aggregate demand function and an expansion of output. 
D) an downward shift in the aggregate demand function and a reduction in output. 
E) an upward shift in the aggregate demand function but leaves output intact.

Quizplus · Accepted Answer

A fall in EP/P (price level) could be due to a decrease in aggregate demand or an increase in aggregate supply. Regardless of the cause, it results in a decrease in revenue for firms and therefore, a decrease in output in the short run. This will lead to a downward shift in the aggregate demand curve due to the decrease in consumption and investment. Thus, D is the correct choice as it states a downward shift in aggregate demand function and a reduction in output.

In the Short Run, Any Fall in EP /P