Suppose the economy is initially in equilibrium where real GDP equals potential GDP and the inflation rate is at the target rate.Other things equal,a housing boom will cause aggregate expenditures to increase,which will result in a new,short-run equilibrium.To return GDP to its potential level,the inflation rate will adjust.With adaptive expectations,this moves the economy to another new short-run equilibrium point.Since the housing boom is temporary,the end of the housing boom will move the economy to yet another new equilibrium point.From this point,since expectations are adaptive,the economy will experience ________ as it moves back to long-run equilibrium.
A) a decrease in aggregate demand and an increase in the inflation rate
B) an increase in aggregate supply and an increase in the inflation rate
C) a decrease in aggregate demand and a decrease in the inflation rate
D) an increase in aggregate supply and a decrease in the inflation rate

Question

Quizplus · Accepted Answer

When the housing boom ends, aggregate expenditure will decrease, resulting in a decrease in GDP. To return to potential GDP, the economy must increase aggregate supply. As expectations are adaptive, people will adjust their expectations of future prices to lower than what was previously anticipated, reducing the inflation rate. Therefore, the correct answer is an increase in aggregate supply and a decrease in the inflation rate, which is choice D.

Suppose the Economy Is Initially in Equilibrium Where Real GDP