Suppose that prices are sticky in the short-run. Which of the following best describes the economy's response to a positive demand shock?
A) Firms' inventories will increase, causing them to cut production. Ultimately, real GDP will decrease and unemployment will increase.
B) Firms' inventories will decrease, causing them to increase production. Ultimately, real GDP will increase and unemployment will decrease.
C) Firms' inventories will increase, causing them to cut production. Ultimately, real GDP will increase and unemployment will increase.
D) Firms' inventories will increase, causing them to cut production. Ultimately, real GDP will decrease and unemployment will decrease.

Question

Quizplus · Accepted Answer

In the short-run, prices are sticky and do not adjust immediately to changes in demand. As a result, a positive demand shock will initially lead to an increase in demand for goods and services, causing firms' inventories to decline. To meet this increased demand, firms will increase production to avoid shortages. This increase in production ultimately results in an increase in real GDP and a decrease in unemployment. Therefore, option B is the best choice.

Suppose That Prices Are Sticky in the Short-Run