The economy is in a recession. The self-correcting mechanism will restore full employment by____ the aggregate price level and shifting the short-run aggregate supply curve to the ___.
A. raising; right
B. raising; left
C. lowering; right
D. lowering; left
The correct answer and explanation is :
The correct answer is: C. lowering; right
Explanation (300 words):
When an economy is in a recession, it means actual output is below potential output, and unemployment is higher than the natural rate. In the short run, this can occur due to a drop in aggregate demand (AD), causing the economy to operate below full employment. The self-correcting mechanism in the economy works through changes in prices and wages, without any government intervention.
In a recession, because demand is weak, there is downward pressure on the aggregate price level. Over time, as prices and especially nominal wages fall, input costs for businesses decline. Lower costs make production more profitable, which encourages firms to increase output. This causes the short-run aggregate supply (SRAS) curve to shift to the right.
This shift continues until the economy returns to its long-run equilibrium at full employment, but now with a lower price level. Importantly, this adjustment happens naturally through market forces—wages and prices responding to economic slack.
Thus, the self-correcting mechanism restores full employment by:
- Lowering the aggregate price level (reducing costs for producers),
- And shifting the SRAS to the right (increasing output as production becomes more profitable).
No fiscal or monetary policy is required in this process, although governments often intervene to speed up recovery. But if left alone, the economy tends to move back to potential output through this supply-side adjustment.
Therefore, the correct response is:
C. lowering; right.