Difficulty: Medium

Average Score: 50%

What happens when there is a decrease in aggregate demand but no change in aggregate supply in the long run

Rationale

A decrease in the price level with no change in the potential real GDP.

When aggregate demand decreases, the overall demand for goods and services in the economy declines, leading to a lower price level in the long run. However, potential real GDP, which reflects the economy's maximum sustainable output, remains unchanged as it is determined by factors such as technology and resources rather than demand fluctuations.

A (A decrease in the price level with no change in the potential real GDP) CORRECT

This choice accurately reflects the economic theory that a decrease in aggregate demand results in lower price levels while the economy's potential output remains constant. In the long run, prices adjust to the new level of demand, but the potential real GDP stays the same, as it is fundamentally linked to supply-side factors.

B (A decrease in the potential real GDP but no change in the price level) YOUR ANSWER

This option is incorrect because a decrease in aggregate demand does not affect potential real GDP, which is determined by long-term factors such as labor, capital, and technology. The price level may change, but potential GDP remains constant unless there are shifts in supply-side conditions.

C (An increase in the potential real GDP but no change in the price level) YOUR ANSWER

This choice is also incorrect, as decreases in aggregate demand do not lead to an increase in potential real GDP. Potential GDP is influenced by structural factors and does not fluctuate with demand changes. The price level may change, but the potential output remains stable.

D (An increase in the price level with no change in the potential real GDP) YOUR ANSWER

This option contradicts basic economic principles. A decrease in aggregate demand would result in a lower price level, not an increase. Potential real GDP remains unchanged, but the price adjustment reflects the reduced demand for goods and services.

Conclusion

In the long run, a decrease in aggregate demand leads to a lower price level without affecting potential real GDP. Aggregate supply remains unchanged; hence, the economy's capacity to produce at full efficiency is not compromised. Understanding this relationship is crucial for analyzing economic fluctuations and their impact on price levels and output.

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