Consider the AD/AS model after factor prices have fully adjusted to output gaps.A reduction in the level of potential output,with aggregate demand constant,will
A)leave real output unaffected and increase the price level.
B)decrease real output and decrease the price level.
C)decrease real output and leave the price level unchanged.
D)decrease real output and increase the price level.
E)increase real output and decrease the price level.

Question

Quizplus · Accepted Answer

When there is a reduction in the level of potential output, the long-run aggregate supply (LRAS) curve will shift to the left. At the same time, aggregate demand (AD) curve stays constant. The intersection of the AD and new LRAS curves will result in a new equilibrium with a lower level of real output (Y) and higher price level (P). Therefore, the correct answer is D: decrease real output and increase the price level.

Consider the AD/AS Model After Factor Prices Have Fully Adjusted