Question

Assuming that the economy is currently in a long-run equilibrium at Y*, a subsequent negative aggregate demand shock with no change in the money supply will eventually result ina. No change in the price level.

b. An ongoing inflation in the economy.
c. A lower price level and GDP below potential output.
d. A higher price level and GDP at potential GDP.
e. A lower price level and GDP at its potential level.

Answer 1

In the long run, a negative aggregate demand shock results in the economy returning to its potential GDP with a lower price level, reflecting the neoclassical view that changes in aggregate demand have only a short-run impact on output and unemployment.

Step-by-step explanation:

Assuming that the economy is currently in a long-run equilibrium at Y*, a subsequent negative aggregate demand shock with no change in the money supply will eventually result in a lower price level and GDP at its potential level, according to the neoclassical perspective. In the short run, a negative aggregate demand shock may lead to higher unemployment and lower output than potential GDP.

However, in the long run, as the short-run Keynesian aggregate supply curve shifts to the right (due to lower wages and input costs), the economy will adjust and return to its potential GDP, with a lower price level due to decreased aggregate demand.