If the economy is operating on the long-run aggregate supply curve, then expansionary fiscal policy will
A) generate higher prices in the short run, but will induce aggregate supply to increase in the long run.
B) generate an increase in real GDP and higher prices in both the short run and the long run.
C) generate an increase in real GDP without higher prices in the short run, but then real GDP will return to its long-run level, and the price level will increase.
D) generate an increase in real GDP and higher prices in the short run, but then real GDP will decrease to its long-run level, and the price level will increase some more.

Question

Quizplus · Accepted Answer

When the economy is operating on the long-run aggregate supply curve, it is at its full employment level. Expansionary fiscal policy in this context will initially increase demand, leading to higher prices and real GDP in the short run. However, since the economy is already at its potential output, real GDP cannot increase in the long run; it will return to its long-run level. The increase in demand will continue to put upward pressure on prices, leading to a higher price level.

If the Economy Is Operating on the Long-Run Aggregate Supply