Question

Explain why its possible to temporarily achieve output levels beyond the economys long-run potential. Why cant the high rates of output be sustained?

Answer 1

Output level can go beyond the potential output on a temporary basis due to the excess aggregate demand in the economy taking place due to the expansionary monetary and fiscal policy. Here, lower interest rates and government spending combine together to make more money chasing few goods. As a result, short run aggregate demand moves to the right to the potential level of output and intersect with the short run aggregate supply. Here the intersection point between SR AD and SR AS will produce output beyond the level of potential output.  
High rates of output beyond the potential level of output is not sustainable, because the demand pull inflation sets in at the higher level of output. Due to this, the cost of production increases and short run aggregate supply curve shift to the left. Due to this shift, the output level falls back to the potential output level, but at a higher price.