13 An inflationary gap can theoretically close on its own be

13) An inflationary gap can theoretically close on its own because. a) Aggregate supply will gradually shift to the right as input prices decrease in the time of inflation. b) Aggregate demand will gradually shift to the right as input prices decrease in the time of inflation. c) Aggregate demand will gradually shift to the left as input prices increase in the time of inflation. d) Aggregate supply will gradually shift to the left as input prices increase in the time of inflation. e) None of the above.

Solution

An inflationary gap means short run equilibrium outcome is greater than potential level of GDP. This will create more employment as firms need to hire more employees to produce this increased output. Increased employment and inflation will put an upward pressure on wages as workers have a relatively large amount of bargaining power with the employers. As a result, input price i.e. cost of hiring labors increases. This will lead to a decrease in Aggregate supply because of increase in input cost. Aggregate supply curve will shift to the left and inflationary gap will close down as the economy moves back to potential GDP level.

Answer- option D