Suppose the economy is initially at full-employment equilibrium real GDP. If a sudden adverse demand shock causes recessionary gap, we can expect one of the following adjustments to occur:

Question

Quizplus · Accepted Answer

Following an adverse demand shock that causes a recessionary gap, the typical adjustment mechanism in the economy involves lower wage rates. This reduction in wage rates makes production more cost-effective, leading to a rightward shift of the short-run aggregate supply (SRAS) curve. This adjustment continues until the economy returns to its potential GDP, where the SRAS curve intersects the aggregate demand (AD) curve at full employment.

Suppose the Economy Is Initially at Full-Employment Equilibrium Real GDP