Refers to Exhibit 4. Suppose the economy is operating in a recession such as point B in Exhibit 4. If policy makers allow the economy to adjust to the long run natural rate on its own, ?
Correct answer: A. People will reduce their price expectations and the short run aggregate supply will shift right
- A. People will reduce their price expectations and the short run aggregate supply will shift right
- B. People will raise their price expectations and aggregate demand will shift left
- C. People will raise their price expectations and the short run aggregate supply will shift left
- D. People will reduce their price expectations and aggregate demand will shift right
Explanation
In a recession, actual output is below its natural level, so wages and price expectations gradually fall. Lower expected prices shift short-run aggregate supply rightward until output returns to its natural rate.
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