In the extended AD-AS model, what eventually happens following an increase in price level associated with an economy exceeding the full employment level?

Question

Multiple choice question.

Output falls below potential GDP.

Net exports shrink and investment spending falls.

Nominal wages remain fixed due to increased input prices.

The short-run aggregate supply curve shifts to the left.

Answer 1

In the extended AD-AS model, when an economy exceeds the full employment level, typically the following happens:

The short-run aggregate supply curve shifts to the left.

This is because as the economy operates above full capacity, it leads to upward pressure on wages and input costs, which reduces the short-run aggregate supply.

Therefore, the correct answer is:

The short-run aggregate supply curve shifts to the left.