Question

If aggregate supply remains unchanged, a decrease in aggregate demand may

a. cause demand-pull inflation.

b, move potential real GDP to the left.

c. put upward pressure on the price level.

d. cause a recession.

e. eliminate a recessionary GDP gap.

Answer 1

Since a recession is the time period of the economy in which the price level is quite low and the demand for goods and services is also very low. So the unemployment rate is very high, therefore the purchasing power is very low. Therefore there is a need for government intervention by increasing its expenditure and decreasing tax rate. So that aggregate demand could increase.

Since equilibrium is determined by the equality of aggregate demand and aggregate supply. So initial equilibrium price is P and quantity of real GDP is Yp that is potential real GDP. But when aggregate demand decreases, then the AD curve shifts leftward, so the price level decreases to P1 and real GDP decreases to Y1. Since aggregate demand has decreased and price level has decreased, so it is a situation of recession.

The potential real GDP remains same because there is no decrease in the production potential.

Hence option d is the correct answer.