If the economy is in equilibrium at full employment, an increase in aggregate demand will:
A) increase the price level and leave the level of output unchanged in the short run.
B) decrease both the price level and the level of output in the short run.
C) decrease the price level and leave the level of output unchanged in the short run.
D) increase both the price level and the level of output in the short run.

Question

Quizplus · Accepted Answer

If the economy is in equilibrium at full employment, there is no spare capacity, and any increase in aggregate demand will drive up prices in the short run. Firms will increase production to meet the higher demand, but since they can't hire more workers due to full employment, they will have to pay higher wages to retain employees. This increase in wages will increase costs, and firms will pass on some of these costs to consumers in the form of higher prices. Therefore, an increase in aggregate demand will increase both the price level and the level of output in the short run.

If the Economy Is in Equilibrium at Full Employment, an Increase