Multiple Choice Suppose the economy is in long-run equilibrium and the governmen
ID: 1198993 • Letter: M
Question
Multiple Choice
Suppose the economy is in long-run equilibrium and the government decreases its expenditures. Which of the following helps explain the logic of why the economy moves back to long-run equilibrium?
A) As people revise their price-level expectations upward, firms and workers strike bargains for higher nominal wages.
B) As people revise their price-level expectations upward, firms and workers strike bargains for lower nominal wages.
C) As people revise their price-level expectations downward, firms and workers strike bargains for higher nominal wages.
D) As people revise their price-level expectations downward, firms and workers strike bargains for lower nominal wages.
Explanation / Answer
Correct option: (D) as people revise their price level expectations downward, firms and workers strike bargains for lower nominal wages.
A fall in government expenditure implies a contractionary fiscal policy. As a result of fall in government expenditure, consumer demand falls, shifting the AD curve to the left. As a result, price level will fall along with the output. So, worker will start expecting lower prices, and will thus bargain for comparatively lower wages.
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