Refer to the figure and assume the economy initially is in equilibrium at point a. In the new classical theory, an unanticipated increase in aggregate demand from AD₂ to AD₁ would move the economy A) directly from a to d. B) from a to b to d. C) from a to e to d. D) directly from a to f.

Question

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According to the new classical theory, an unanticipated increase in aggregate demand leads to a temporary increase in output and employment, with prices remaining unchanged in the short run. As a result, the economy moves from point a to point e, where output is temporarily higher but still at the natural level of output. However, in the long run, wages and prices adjust to the increased demand, shifting the short-run aggregate supply curve to the left until it intersects with the new aggregate demand curve at point d. At point d, output returns to the natural level, but prices are higher than before the aggregate demand shock.

Refer to the Figure and Assume the Economy Initially Is