Final answer:
In the long run following a positive demand shock, wages and aggregate price level will adjust, causing the economy to return to its potential GDP. The short-term increase in real GDP and wages is not sustained, and price levels may face downward pressure as the supply curve shifts right.
Step-by-step explanation:
When an economy experiences a positive demand shock, there are typically short-term and long-term effects on wages, the aggregate price level, and real GDP. In the short term, a positive demand shock can lead to increased production to meet the higher demand, resulting in higher wages as firms compete for workers and a higher aggregate price level due to increased spending. However, according to the neoclassical perspective, in the long run, these effects are transient.
Wages that might increase initially due to higher demand will eventually adjust as the market seeks equilibrium, potentially leading to wage stagnation or even reductions if unemployment subsequently rises. This wage adjustment can shift the short-run Keynesian aggregate supply curve to the right, which in turn, exerts a downward pressure on the aggregate price level. Meanwhile, real GDP would return to the potential GDP level as the economy self-corrects and adjusts back to full employment output.
These adjustments mean that in the long run, despite a positive demand shock initially causing a spike in economic activity, the economy will eventually stabilize at its potential GDP with no permanent change to unemployment and a downward adjustment of the price level. The timeframe for this adjustment can be contentious among economists (Keynesian vs. neoclassical), with some speculating it could take a considerable period, even up to ten years.