Suppose there is a contractionary gap and the economy is in equilibrium on the SRAS at an output level beyond the economy's long-run real GDP.In the short run,if the government decreases spending then

Question

Quizplus · Accepted Answer

If the government decreases spending, it will further decrease aggregate demand in the economy, which will lead to a decrease in output. However, since the economy was already beyond its long-run real GDP, the decrease in output will not lead to a decrease in prices. Instead, the decrease in aggregate demand will lead to a new equilibrium point on the SRAS curve with both lower output and lower prices. Therefore, the correct choice is C - output and prices will fall.

Suppose There Is a Contractionary Gap and the Economy Is