When the actual price level in an economy turns out to be lower than that expected in the short run, firms _____
A) produce less than the economy's potential output.
B) produce more than the economy's potential output.
C) produce the same as the economy's potential output.
D) increase the quantity supplied.
E) an expansionary gap develops.

Question

Quizplus · Accepted Answer

When the actual price level turns out to be lower than expected, firms will experience lower revenues and profit margins, which will reduce their incentive to produce as much as they would have at higher price levels. Therefore, they will produce less than the economy's potential output, resulting in a recessionary gap.

When the Actual Price Level in an Economy Turns Out