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IAI Actuarial Core Principles · Business Economics · Impact of macroeconomic policies on businesses

An economy has a vertical long-run aggregate supply curve at potential output. A government introduces reforms that raise labour productivity, while aggregate demand is unchanged in the short run. Which combination best describes the resulting change, assuming prices are initially flexible upward and downward?

Output rises and the price level falls. Productivity reforms lower costs and shift aggregate supply to the right. With aggregate demand unchanged, the new equilibrium is at a larger output and lower prices, improving cost competitiveness for firms, including exporters.

  1. AOutput rises and the price level rises
  2. BOutput rises and the price level fallsCorrect
  3. COutput falls and the price level falls
  4. DOutput is unchanged and the price level falls
  5. Output rises and the price level is unchanged

Explanation

Higher productivity lowers unit costs and shifts both short-run and long-run aggregate supply right. With aggregate demand fixed, the new intersection is at higher output and a lower price level. A rise in prices would need a demand increase, and unchanged prices would need a perfectly elastic supply curve.

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