Suppose the economy is in long-run equilibrium. In a short span of time, there is a pessimistic revision of expectations about future business conditions and an unexpected rise in the value of the dollar. In the short run, we would expect
A) the price level and real GDP both to rise.
B) the price level and real GDP both to fall.
C) the price level and real GDP both to stay the same.
D) All of the above are possible.

Question

Quizplus · Accepted Answer

A pessimistic revision of expectations about future business conditions would cause a decrease in aggregate demand (AD), shifting the AD curve to the left. An unexpected rise in the value of the dollar would cause a decrease in net exports, shifting the net exports component of AD to the left as well. In the short run, this decrease in AD would lead to a decrease in both price level and real GDP. However, in the long run, prices and wages would adjust, shifting the SRAS curve to the right, and the economy would return to potential output with a lower price level.

Suppose the Economy Is in Long-Run Equilibrium