Question

Suppose a recession occurs as a result of a supply shock, and instead of the economy naturally working its way back to equilibrium, the government uses policy to shift the aggregate demand curve to fight the recession. Using policy this way would quickly result in a new, higher level of real GDP and a permanently lower price level. bring real GDP back to potential GDP more slowly but would bring the price level back to the original price level more quickly. bring real GDP back to potential GDP more quickly but would result in a permanently higher price level. bring the price level back to its original level more quickly but would result in a permanently lower level of potential GDP.

Answer 1

Answer: bring real GDP back to potential GDP more quickly but would result in a permanently higher price level.

Step-by-step explanation:

When the government uses fiscal policy to bring real GDP back to the potential GDP, the movement back to potential GDP occurs faster because the spending by government increases the aggregate demand in the economy much more faster.

A higher price level would be formed permanently however because the spending by government would lead to aggregate demand rising such that prices need to rise in order to reflect that goods are now more scarce in relation to demand.