Answer to Question #82230 in Finance for Muhammad F Chaudhry

Question

True or false & explain: Under a free market, in which the self-adjusting mechanism operates efficiently, aggregate demand shocks generate real effects in the short-and long-run.

Answer 1

true

The shock of aggregate demand in the short run has real consequences. If positive, this is an inflationary output gap, and if negative, this is a recessionary output gap (actual GDP is less than potential).

In the free market in the long run deflation will occur. That is, the economy moves to a point of long-run equilibrium.