If the economy is in a recessionary gap:
A) it will remain in a recession forever without any kind of government intervention.
B) nominal wages will fall and SRAS will shift to the right until the economy is at full employment.
C) AD will shift to the right and prices of goods will rise until the economy goes back to producing potential output.
D) nominal wages will rise, SRAS will shift to the left, and the economy will eventually restore itself.

Question

Quizplus · Accepted Answer

In a recessionary gap, there is a deficiency of aggregate demand in comparison to the potential output. In response to this, nominal wages will fall as labor becomes more abundant, lowering the firms' production costs. This will cause SRAS to shift to the right till the economy is back to full employment. Therefore, B is the correct choice. A, C, and D are incorrect because of the reasons mentioned below:
A) The economy will eventually recover on its own, but with the intervention of the government, the process can be made more explicit and smooth.
C) If AD shifts to the right, it will lead to inflationary growth instead of returning to full employment.
D) If nominal wages rise, it will lead to inflation instead of restoring the previous level of employment.

If the Economy Is in a Recessionary Gap