Assuming the economy is starting at the natural rate of output and everything else held constant, the effect of ________ in aggregate ________ is a rise in both the inflation rate and output in the short-run, but in the long-run the only effect is a rise in the inflation rate.
A) a decrease; supply
B) a decrease; demand
C) an increase; supply
D) an increase; demand

Question

Quizplus · Accepted Answer

An increase in aggregate demand will cause a short-run increase in both price level and output, as businesses increase production to meet higher demand. However, in the long-run, as resources are stretched and become more expensive, businesses will not be able to continue producing at higher levels and will instead increase prices, leading to a rise in inflation. A decrease in aggregate demand (choice B) would lead to a short-run decrease in both price level and output, with the opposite long-run effect. A decrease in aggregate supply (choice A) would cause a short-run increase in price level and decrease in output, with a long-run effect of higher prices and no change in output. An increase in aggregate supply (choice C) would cause a short-run decrease in price level and increase in output, with a long-run effect of lower prices and higher output.

Assuming the Economy Is Starting at the Natural Rate of Output