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 price level and output in the short-run,but in the long-run the only effect is a rise in the price level.

Question

Quizplus · Accepted Answer

An increase in aggregate demand will cause a rise in both the price level and output in the short run as businesses are unable to immediately adjust production to meet the increase in demand. This results in inflationary pressures. However, in the long run, all factors of production become more expensive due to the increase in demand, causing an increase in production costs and a decrease in profitability. Eventually, businesses will reduce production, and the economy returns to the natural rate of output where only the price level has risen.

Assuming the Economy Is Starting at the Natural Rate of Output