Skip to content

IAI Actuarial Core Principles · Business Economics · Business activity, unemployment and inflation

In the classical (Keynesian-contrast) view, long-run aggregate supply is vertical at full-employment output. An economy is at that level when the government permanently raises spending, shifting AD right. Which statement best describes the long-run result after wages and prices fully adjust?

Output returns to its full-employment level while the price level ends permanently higher. The demand boost pushes output above potential temporarily, then rising wages and costs shift short-run supply left until the economy reaches the vertical long-run supply curve at higher prices.

  1. AOutput stays permanently above full employment and prices are stable
  2. BOutput returns to full-employment level and the price level is permanently higherCorrect
  3. COutput returns to full-employment level and the price level returns to its original value
  4. DOutput falls below full employment and prices fall
  5. Output rises permanently and unemployment falls permanently with no price change

Explanation

Initially output rises above potential, tightening the labour market. Wages and input costs then rise, shifting SRAS left until output returns to the vertical LRAS, leaving a higher price level. Prices do not return to the original value because AD remains higher.

Did you get it right without looking?

One question tells you little. A timed set on Business activity, unemployment and inflation shows your real accuracy, how long you take and where you lose marks.

Practise Business activity, unemployment and inflationFree diagnostic mock

More Business activity, unemployment and inflation questions