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 would lead to a decrease in both output and prices. As the economy initially moves from Y* to a level below it, there will be an increase in unemployment and decrease in prices. Over time, however, as prices adjust downwards, the economy will return to its long-run equilibrium at a lower level of output but with a lower price level. Therefore, the best choice would be E, a lower price level and GDP at its potential level.

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