Suppose the economy is in long-run equilibrium. In a short span of time, there is a decline in the money supply, a tax increase, a pessimistic revision of expectations about future business conditions, and a rise in the value of the dollar. In the short run, we would expect
A)the price level and real GDP both to rise.
B)the price level and real GDP both to fall.
C)the price level and real GDP both to stay the same.
D)All of the above are possible.

Question

Quizplus · Accepted Answer

A decline in the money supply and a tax increase would both lead to a decrease in aggregate demand and therefore a decrease in both the price level and real GDP. The pessimistic revision of expectations would further decrease investment and consumption, exacerbating this effect. A rise in the value of the dollar would also decrease net exports, decreasing aggregate demand even further. Therefore, both the price level and real GDP are expected to fall in the short run.

Suppose the Economy Is in Long-Run Equilibrium