Explain whether you agree with the following statement: \"The dynamic aggregate

Question

Explain whether you agree with the following statement:

"The dynamic aggregate demand and aggregate supply model predicts that a recession caused by a decline in AD will cause the inflation rate to fall. I know that the 2007 2009 recession was caused by a fall in AD, but the inflation rate was not lower after the recession. The prices of most products were definitely higher in 2008 than they were in 2007, so the inflation rate could not have fallen."

A. The statement is wrong because there must have been a supply shock if prices rose and there was a recession.

B. The statement is wrong because it is confusing the price level with the inflation rate.

C. The statement is correct as prices rose in 2008.

D. The statement is wrong because AD must have increased if prices were higher.

Explanation / Answer

B. The statement is wrong because the author is confusing the price level with the inflation rate.

To say that inflation rate falls only when price falls is a false assumption because fall in inflation rate clearly occured when the prices rose at a relatively slower speed than the previous year.

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