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Consider the simple Keynesian model in the AD-AS framework. Currently the economy is located in the...

Consider the simple Keynesian model in the AD-AS framework. Currently the economy is located in the horizontal section of the AS curve producing Q1. If aggregate demand rises, then

a.the price level will rise.

b.the price level may rise.

c.the price will decline.

d.Real GDP will rise.

e.none of the above

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Answer #1

Correct option is (d).

If aggregate demand increases from current level of AD in the horizontal section of AS curve, price level remains unchanged if new AD intersects AS in its horizontal portion, and price level will increase if new AD intersects AS in its upward rising portion. But in both cases, real GDP will definitely increase.

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Answer #2

e. none of the above

In the Keynesian model in the AD-AS framework, the horizontal section of the AS curve represents a situation of output (Real GDP) being at the full-employment level, but there is still spare capacity in the economy, and the price level is fixed. In this case, if aggregate demand (AD) rises, it will lead to an increase in Real GDP (output) without causing any change in the price level (inflation) since the economy is already at its full-employment level. Therefore, none of the options listed (a, b, c, d) is correct.

answered by: Hydra Master
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