Question

Suppose the government increases aggregate demand to a level that increases GDP above its long-run equilibrium level. What sequence of events would follow?

a. prices fall; workers receive lower wages; short-run aggregate supply shifts to the right; GDP rises
b. prices fall; workers receive lower wages; aggregate supply shifts to the right; GDP rises
c. prices rise; GDP increases; workers demand higher wages; short-run aggregate supply shifts to the left; GDP drops
d. prices rise; GDP increases; workers demand higher wages; long-run aggregate supply shifts to the left; GDP falls

Answer 1

An increase in aggregate demand above the long-run equilibrium level would lead to a sequence of events, including shifts in the supply and demand curves and changes in wages and prices. The economy would eventually reach a new equilibrium with a higher price level. Option C is correct.

Step-by-step explanation:

In the short-run Keynesian analysis, an increase in aggregate demand above the long-run equilibrium level of GDP would lead to a sequence of events.

First, the rise in aggregate demand would shift the aggregate demand curve to the right, leading to a new equilibrium with higher output, lower unemployment, and pressure for an inflationary rise in the price level.

As the aggregate demand increases, employers would try to bid workers away from other companies and encourage current workers to work longer hours, driving up wages.

The increase in wages would result in a leftward shift in the short-run aggregate supply curve, as the price of a major input to production has increased. This brings the economy to a new equilibrium with the same level of real GDP but a higher price level.