Question

14. Consider starting from full-employment equilibrium in our Aggregate Demand and Supply model (with flexible wages and worker misperception of price level changes in the short run), at Po, Qn on the output market graph below. Then we get a decrease in Aggregate Demand from Agg D, to Agg D1. P LR Agg S SR Agg S. Agg D 0 Agg D1 Q Q1 N We can say that O In the long run, P and Q will return to original levels when workers perceive the decrease in P. at P1, Q1, we see that we had economic growth. In the long run, Q will increase back toward QN as workers take pay cuts that match the deflation rate. at P1, Q1, we see that we were in an inflationary gap. none of the other options.

Answer 1

Answer
Option 3
The long-run output is Qn and the decrease in AD decreases the output to Q1 so the actual output is less than the potential output means there is a recessionary gap.
In the long run, wages decrease because of the recessionary presser, and SRAS shifts to the right so the Q will be back to the Qn.
To get back to the same price and output level the government needs to intervene.