Suppose that an economy is in an inflationary gap in the short run. In the long run:
A) the economy's self-correcting mechanism will restore GDP to its potential level.
B) inflation will spiral unless the government takes dramatic fiscal measures.
C) sustained inflation will reduce the value of money.
D) fiscal and monetary policies may lower prices, but output will remain higher than potential level.

Question

Quizplus · Accepted Answer

In the long run, an economy's self-correcting mechanism will restore GDP to its potential level, reducing the inflationary gap. This mechanism involves adjustments in wages and prices that decrease aggregate demand until it matches the potential output. Therefore, the economy will return to its long-run equilibrium and produce at its potential level without spiraling inflation or the need for dramatic fiscal measures.

Suppose That an Economy Is in an Inflationary Gap in the Short