Starting from potential output, if consumer confidence decreases and consumers d

Question

Starting from potential output, if consumer confidence decreases and consumers decide to spend less, then this will generate a(n)output gap and the price level will 1. ceteris paribus. a) inflationary; decrease b) inflationary; increase c) recessionary; decrease d) recessionary; increase 2. Ceteris paribus, a decrease in the costs of widely used factors of production would most likely: a) Increase short run aggregate supply b) Decrease aggregate demand c) Decrease short run aggregate supply d) Increase aggregate demand Government intervention policies to correct output gaps primarily target the aggregate demand curve because consumer behavior and investment are easier to manipulate than short run aggregate supply. a) True b) False

Explanation / Answer

1. c. recession, decrease

The recessionary gap appears when actual output is less than potential output. This will lead to decrease in the downward sloping aggregate demand curve. It will shift left and this will decrease prices.

2. a. Increase short-run AS. Decrease in cost of production let suppliers sell more output at the same price.

3. a. True. Also, supply increases with a time lag and by that time condition might get serious. So, it is always better to target consumers.

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