Suppose the economy begins in a long- run equilibrium with Y = Y*. A permanent increase in aggregate demand will have its short- run effect on real GDP reversed in the long run with a shift of _ .
A)leftward; the aggregate demand curve
B)rightward; the aggregate demand curve
C)leftward; the aggregate supply curve
D)rightward; the aggregate supply curve
E)rightward; Y*

Question

Quizplus · Accepted Answer

In the short run, a permanent increase in aggregate demand will cause real GDP to increase above its long-run equilibrium level, leading to inflationary pressures. However, in the long run, prices will adjust to this increase in demand, leading to an increase in production costs (due to higher input costs) and a decrease in profits. As a result, firms will reduce production and real GDP will return to its long-run equilibrium level, but at a higher price level. This adjustment process is represented by a leftward shift of the aggregate supply curve.

Suppose the Economy Begins in a Long- Run Equilibrium with Y