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Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985

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BuyFindarrow_forward

Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985
Textbook Problem

An increase in the aggregate demand for goods and services has a larger impact on output _____ and a larger impact on the price level _____.

a. in the short run, in the long run

b. in the long run, in the short run

c. in the short run, also in the short run

d. in the long run, also in the long run

To determine

The impact of increased AD on output and price.

Explanation

The demand comes from all the economic agents such as the households, firms as well as the government. The demand depends on the price level of the economy. The increase and decrease in the price level determines the level of demand in the economy. The aggregation of all the individual demands in the economy is known as the aggregate demand thus, the aggregate demand explains the relationship between the general price level and the level of real GDP demanded in the economy by the economic agents such as the households, firms and the government.

Option (a):

The increased aggregate demand in the short run will impact the output of the economy more in the short run. This is because, the increased aggregate demand forces the firms to increase their output which induces the output of the economy to largely increase in the short run. In the long run, it will not impact much because the long run AS curve is unaffected by the fluctuations in the demand. Similarly, the short run price level will be impacted by smaller proportion compared to the long run because, the price level increases largely in the long run. The short run increase in the output will revert back to the LRAS in the long run which brings the output back to equilibrium but at a higher price level. So, option 'a' is correct.

Option (b):

The output increases in the short run when the aggregate demand in the economy rises. This increases the price level which reduces the aggregate demand and brings the output back into the equilibrium level output but at a higher price level...

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