Exhibit 17-2 Aggregate demand and aggregate supply curves As shown in Exhibit 17-2, if people behave according to adaptive expectations theory, an increase in the aggregate demand curve from AD₁ to AD₂ will cause: A) labor to adjust nominal wages immediately. B) the aggregate supply curve to shift from SRAS₁ to SRAS₂ C) the price level to eventually fall from 110 to 100. D) real GDP to rise from $6 trillion to $6.5 trillion permanently.

Question

Quizplus · Accepted Answer

According to adaptive expectations theory, workers and firms adjust their expectations of future prices and wages based on past trends. Therefore, in the short run, an increase in aggregate demand will lead to a temporary increase in both the price level and real GDP, with no immediate adjustment of nominal wages. As a result, the aggregate supply curve will shift to the right from SRA₁ to SRA₂, reflecting the temporary increase in real GDP. However, over time, workers and firms will adjust their expectations and nominal wages will eventually rise, causing the aggregate supply curve to shift back to the original position. Therefore, the price level will eventually fall back to 100, and real GDP will return to its original level of $6 trillion.

Exhibit 17-2 Aggregate Demand and Aggregate Supply Curves