If prices and wages are ﬂexible, a decrease in aggregate demand will in the long run cause only a(n)
A) decrease in the price level.
B) increase in the price level.
C) increase in the unemployment rate.
D) decrease in real output.

Question

Quizplus · Accepted Answer

With flexible prices and wages, a decrease in aggregate demand will cause a decrease in the price level in the long run. This is because as demand decreases, firms will lower their prices to maintain sales levels, and with lower demand for goods, there will be downward pressure on wages as well. As prices and wages adjust to the lower level of demand, the economy will reach a new equilibrium with a lower price level but no change in real output or unemployment rate.

If Prices and Wages Are ﬂExible, a Decrease in Aggregate