Consider the AD/AS macro model. A permanent demand shock that causes equilibrium output to rise above potential output will
A)allow a stable expansion of real income over time.
B)be negated in the long run, through the economy's adjustment process.
C)result in a price level lower than that preceding the demand shock.
D)always reverse itself.
E)set off an endless cycle of price rises and increases in unemployment.

Question

Quizplus · Accepted Answer

In the long run, the economy will adjust and shift the short-run aggregate supply curve leftward, returning output to potential and negating the demand shock. This adjustment process may involve higher wages, increased investment, and technological advances that boost productivity. As a result, the price level may end up higher, lower, or the same as before the demand shock, depending on the specifics of the adjustment process. However, the economy will not get stuck in an inflationary spiral or deflationary spiral, as the AD/AS model emphasizes the self-correcting nature of market forces.

Consider the AD/AS Macro Model