Starting from long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, a five-period positive demand shock causes output to _____ until returning to the natural level in the long run.
A) remain continuously above the natural level of output
B) move above and then below the natural level of output
C) remain continuously below the natural level of output
D) move below and then above the natural level of output

Question

Quizplus · Accepted Answer

In the short run, the positive demand shock shifts the AD curve to the right, causing output to increase above the natural level. However, as prices adjust over time, the SRAS curve shifts to the left and eventually intersects with the long-run AD curve at the natural level of output. Therefore, in the long run, output returns to its natural level, but in the short run, it initially moves above and then below the natural level.

Starting from Long-Run Equilibrium in the Dynamic Model of Aggregate