Holding the level of prices fixed implies that a given decrease in aggregate demand
A) will have a smaller effect on real GDP than would be the case if prices were more flexible.
B) will have a larger effect on real GDP than would be the case if prices were more flexible.
C) has the same effect on real GDP as when prices are more flexible.
D) has a smaller effect on nominal GDP than when prices are more flexible.

Question

Quizplus · Accepted Answer

When the level of prices is fixed, a decrease in aggregate demand will lead to a larger effect on real GDP than if prices were more flexible. This is because with fixed prices, firms are unable to adjust their prices downwards, leading to a fall in output and employment. In contrast, when prices are more flexible, firms are able to adjust their prices downwards, which helps to cushion the impact of a fall in aggregate demand on real GDP. Therefore, with fixed prices, the impact of a decrease in aggregate demand on real GDP is larger.

Holding the Level of Prices Fixed Implies That a Given