Final answer:
In the short run, increased savings by households lead to decreased output, employment, and price levels (option d) due to reduced aggregate demand. In the long run, the economy is expected to adjust and return to potential GDP, though there is disagreement over how quickly this will occur between Keynesian and neoclassical economists.
Step-by-step explanation:
If households decide to save a larger portion of their income, it will have various effects on the economy in the short run versus the long run. In the short run, increased savings would lead to a decrease in consumption, which in turn reduces aggregate demand. As a result, this would likely cause a decrease in output, employment, and price level. Businesses would see a drop in sales, potentially leading to layoffs and reduced production. Since there's less spending, there's less demand for goods and services, which can lead to lower prices.
In the long run, however, the effects are different. According to neoclassical economic theory, the economy will adjust. Higher savings can lead to an increase in the capital stock due to more funds being available for investment, which can lead to growth in productivity and output. As the market adjusts, wages and prices become flexible, allowing the economy to return to its potential GDP. Over time, this can lead to a balance where the level of output returns to potential GDP, and employment stabilizes, though there may still be downward pressure on the price level.
How Fast Is the Speed of Macroeconomic Adjustment? This question illustrates the contention between Keynesian and neoclassical economists regarding the pace at which the economy self-corrects. Neoclassical economists believe that the economy will eventually return to its full potential, while Keynesians may argue that without intervention, the adjustment period could be unacceptably long, rendering the self-correction mechanism inefficient.