Answer to Question #82231 in Macroeconomics for Muhammad F Chaudhry

Question

True or false & explain: Under a free market, in which the self-adjusting mechanism operates efficiently, aggregate demand shocks generate real effects in the short-and long-run.

Answer 1

true

In the short term, a positive shock of aggregate demand is manifested in the appearance of an inflationary output gap. And the negative shocks of aggregate demand leads to a decrease in output and mean the transition of the economy to a point of short-term equilibrium. A recessionary output gap appears - a situation where actual GDP is less than potential.

Under conditions of perfect competition, deflation will occur and the economy will fall into a point of long-run equilibrium, where production is equal to potential.