An economy in long-run equilibrium experiences an increase in aggregate demand. According to the classical model,
A) the price level will rise first, then real GDP will increase.
B) the price level and real GDP will increase at the same time.
C) the price level will increase, but real GDP will not change.
D) the price level will increase, but real GDP will decrease.

Question

Quizplus · Accepted Answer

According to the classical model, the economy is always at full employment in the long run. Thus, any increase in aggregate demand will only cause an increase in the price level, not in real GDP. This is because the only thing that can increase real GDP in the long run is an increase in the economy's capacity to produce, such as through increases in capital and technology. Therefore, in the short run, the price level will increase, but real GDP will remain constant.

An Economy in Long-Run Equilibrium Experiences an Increase in Aggregate