If the government increases aggregate demand when the economy is at both short-run and long-run equilibrium, the full long-run effect of this fiscal policy will be to
A) increase real Gross Domestic Product (GDP).
B) increase the price level.
C) increase either the real Gross Domestic Product (GDP) or the price level, depending on the length of the time lag.
D) decrease both real Gross Domestic Product (GDP) and the price level.

Question

Quizplus · Accepted Answer

If the economy is at both short-run and long-run equilibrium, then the economy is currently producing at its potential output and the price level is at its equilibrium level. When the government increases aggregate demand through fiscal policy, this will initially cause an increase in both real GDP and the price level in the short run. However, in the long run, the increase in aggregate demand will lead to an increase in the price level, but the economy will return to its potential output, and real GDP will not be affected. Therefore, the full long-run effect of this fiscal policy will be to increase the price level.

If the Government Increases Aggregate Demand When the Economy Is