Within the AD/AS model, how does an economy adjust to an output beyond its long-run capacity as a result of an unanticipated increase in aggregate demand?
A) Wage rates and resource prices will fall, causing a decrease in aggregate demand and the restoration of equilibrium at a higher price level.
B) Long-run aggregate supply will increase, leading to a new equilibrium at a lower price level.
C) Resource prices and real interest rates will rise causing output to fall back to its long-run sustainable rate.
D) Lower real interest rates will stimulate demand and restore equilibrium at the initial price level.

Question

Quizplus · Accepted Answer

An unanticipated increase in aggregate demand will lead to an output beyond the long-run capacity, causing resource prices and real interest rates to rise. As a result, the cost of production increases, leading to a decrease in output and a restoration of equilibrium at a lower level of output that is sustainable in the long-run. Therefore, option C is the best answer.

Within the AD/AS Model, How Does an Economy Adjust to an Output