In the AD-AS model, what happens to the economy in the short run if aggregate demand increases while aggregate supply remains unchanged?

• A. Output and the price level both increase.
• B. Output increases, but the price level decreases.
• C. Both output and the price level decrease.
• D. Output remains unchanged, but the price level increases.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the components of the AD-AS model. Aggregate Demand (AD) represents the total demand for goods and services in the economy at different price levels, while Aggregate Supply (AS) represents the total output firms are willing to produce at different price levels.
2. Step 2: Recognize that an increase in Aggregate Demand means the AD curve shifts to the right. This shift indicates that at every price level, consumers, businesses, and the government want to buy more goods and services.
3. Step 3: Since Aggregate Supply remains unchanged, the AS curve stays fixed. The intersection of the new AD curve with the unchanged AS curve determines the new short-run equilibrium.
4. Step 4: At the new equilibrium, because AD has increased and AS is constant, the price level rises due to higher demand putting upward pressure on prices.
5. Step 5: Also, the output (real GDP) increases in the short run because firms respond to higher demand and prices by producing more, moving along the AS curve to a higher quantity supplied.