Question

Assume a model with a downward-sloping aggregate demand curve and an upward-sloping aggregate supply curve. In this model, a decrease in aggregate supply will lead to an increase in real GDP and a decrease in the price level.

True or False

Answer 1

Equilibrium occurs when Aggregate demand(AD) and aggregate supply(AS) intersects.

Suppose Aggregate supply decreases. This decrease in aggregate supply will shift AS curve to the left and thus at initial equilibrium price level Now we have excess aggregate demand. This will result in increase in price which results in increase in aggregate quantity supplied and decrease in aggregate quantity(Real GDP) demand and this will continue till both again intersects nd get back to equilibrium. Thus at new equilibrium we have higher price level and lower real GDP. Thus, Price level will increase but Real GDP will decrease.

Hence, This statement is False