Final answer:
In the short run, total spending determines output due to price and wage stickiness, while in the long run, potential GDP and flexible prices and wages determine output. The correct answer to the student's question is D. total spending; potential output. Option D is correct..
Step-by-step explanation:
In economics, it is understood that in the short run, total spending (aggregate demand) determines output because prices and wages are relatively sticky and do not adjust quickly to changes in demand. Conversely, in the long run, output is determined by potential GDP and the aggregate supply, when prices and wages are more flexible and can adjust to levels that match demand with the economy's potential to produce.
Therefore, the correct answer to the question is: In the short run, total spending determines output, and in the long run potential output determines output. Which corresponds to option D. total spending; potential output. In the short run, an increase in savings by households would lead to a decrease in total spending, reducing output, employment, and putting downward pressure on the price level. In the long run, however, the economy adjusts. Wages and prices become more flexible, which can lead to adjustments that bring the economy back to its potential GDP.