Suppose the economy is in long-run equilibrium. In a short span of time, there is a sharp decline in the stock market, a tax cut, an increase in the money supply, and a decline in the value of the dollar. In the short run, what would we expect to happen?
A)the price level and real GDP both to rise
B)the price level and real GDP both to fall
C)the price level and real GDP both to stay the same
D)The price level and real GDP may rise, fall, or remain the same.

Question

Quizplus · Accepted Answer

The sharp decline in the stock market, tax cut, and increase in the money supply would all increase aggregate demand in the short run, leading to both an increase in price level and real GDP. However, the decline in the value of the dollar would lead to an increase in net exports, which would increase aggregate demand further, leading to an increase in both price level and real GDP. However, the magnitude of each effect is uncertain, so the price level and real GDP may rise, fall, or remain the same. Therefore, the correct answer is D.

Suppose the Economy Is in Long-Run Equilibrium