Assuming that the economy is currently in a long-run equilibrium at Y^*,a subsequent negative aggregate demand shock with no change in the money supply will eventually result in

Question

Quizplus · Accepted Answer

A negative aggregate demand shock will lead to a decrease in both output and prices. This means that the economy will move from the initial equilibrium (Y^*) to a new equilibrium at a lower level of output and a lower price level (YS2U2P2*S2S2P0). This new equilibrium represents a situation where the actual output is below potential output (Yp), indicating a recessionary gap. Therefore, the correct answer is E - a lower price level and GDP at its potential level.

Assuming That the Economy Is Currently in a Long-Run Equilibrium