Suppose the economy is at a short-run equilibrium GDP that lies below potential GDP.Which of the following will occur because of the automatic mechanism adjusting the economy back to potential GDP?
A)Output will decrease.
B)Prices will increase.
C)Unemployment will rise.
D)Short-run aggregate supply will shift to the right.

Question

Quizplus · Accepted Answer

The automatic mechanism that adjusts the economy back to potential GDP is the self-correcting mechanism of the economy. This mechanism is driven by the adjustments in prices and wages in response to changes in demand and supply. When the economy is at a short-run equilibrium GDP that lies below potential GDP, there is excess capacity in the economy, which puts downward pressure on prices and wages. This, in turn, leads to a decrease in production costs for firms, which increases their profitability and encourages them to increase production. As a result, short-run aggregate supply (SRAS) will shift to the right, which will increase output and decrease the unemployment rate. Therefore, the best choice is D, as none of the other options accurately represents the automatic mechanism of the self-correcting mechanism of the economy.

Suppose the Economy Is at a Short-Run Equilibrium GDP That