Exhibit 17-2 Aggregate demand and aggregate supply curves As shown in Exhibit 17-2, if people behave according to rational expectations theory, an increase in the aggregate demand curve from AD₁ to AD₂ will cause the price level to move: A) directly from 100 to 105 and then remain at 105. B) directly from 100 to 110 and then remain at 110. C) from 100 to 105 initially and then eventually move back to 100. D) from 100 to 105 initially and then eventually move to 110.

Question

Quizplus · Accepted Answer

According to rational expectations theory, an increase in aggregate demand will cause a movement along the short-run aggregate supply curve, leading to an increase in both output and the price level. In this case, the increase in aggregate demand from AD₁ to AD₂ will cause the price level to move directly from 100 to 110 and then remain at 110, as the short-run aggregate supply curve is perfectly elastic in this scenario.

Exhibit 17-2 Aggregate Demand and Aggregate Supply Curves