Final answer:
The correct response to the student's question is that if output is above its natural level, the price level will rise, causing a shift in the SRAS curve and leading to a new equilibrium with higher inflation but unchanged real GDP in the long-run.
Step-by-step explanation:
If output is above its natural level, over time the price level will rise, shifting the short-run Keynesian aggregate supply curve (SRAS) and moving the economy toward its long-run equilibrium. In the long-run neoclassical analysis, when economic output exceeds potential GDP, unemployment decreases below the natural rate, leading to a labor shortage. Employers then respond by raising wages to attract and retain workers. As wages, which are a major input to production, increase, this causes a leftward shift in the SRAS curve, ultimately resulting in a new equilibrium with a higher price level but the same level of real GDP as the original equilibrium, signifying inflation.
This process reflects the relationship depicted by the long-run Aggregate Supply (AS) curve and the vertical Phillips Curve. According to the vertical Phillips curve, regardless of the changes in the price level caused by shifts in aggregate demand, the unemployment rate will return to the natural rate, which remains constant in the long run. Therefore, in response to the student's question, the correct answer is: (a) rise, 1S.