Refer to Figure 13-10. Suppose that output in the economy is currently below ful

Question

Refer to Figure 13-10. Suppose that output in the economy is currently below full employment. If real GDP is $6.8 trillion and a demand shock lowers real GDP to $6.5 trillion, what would we expect to occur in the long run? The aggregate supply curve will shift left as wages fall. No further changes in aggregate supply or aggregate demand without government intervention. The aggregate demand curve will shift right as wages fall. The aggregate demand curve will shift left as wages fall. The aggregate supply curve will shift right as wages fall.

Explanation / Answer

Hi, I don't know what answer was chosen or by whom - but the solution follows.

SOLUTION

Since there is already a recessionary gap since real GDP is below potential GDP, a further lowering of real GDP will further increase the recessionary gap, so price level falls more (below 130) in short run.

In the long run, as prices fall, wage rate falls, which lowers cost of production and so the producers are encouraged to supply more. Aggregate supply curve shifts rightward as wages fall in long run.

The last option is correct.

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