When aggregate output is determined solely by the level of aggregate demand, the relation between aggregate supply and price is?
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → Perfectly Elastic.
When aggregate output is determined solely by the level of aggregate demand, it refers to a situation where the economy has unused capacity or unemployment, often modeled in the Keynesian short-run where:
- There are idle resources / unemployment
- Firms can increase output without increasing cost per unit
- Hence, price level remains constant
In this case, aggregate supply (AS) curve is:
-
Horizontal, meaning perfectly elastic
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Output can increase without any change in price level, as firms can increase production by using idle resources.
- Firms are willing to supply any quantity at the same price