In the vertical range of the aggregate supply curve, greater spending for consumer and investment goods results in:
a. Stagflation.
b. More unemployment.
c. Greater output.
d. A higher price level.
The correct answer and explanation is:
The correct answer is d. A higher price level.
In the vertical range of the aggregate supply (AS) curve, the economy is at or near full employment. This means that all available resources—labor, capital, and land—are being used as efficiently as possible. As a result, when there is an increase in aggregate demand (such as greater spending on consumer and investment goods), there is little to no increase in output. Instead, the only effect of higher demand is an increase in the price level, leading to inflation.
The aggregate supply curve typically has three ranges: a horizontal range, an upward sloping range, and a vertical range. In the vertical range, the economy has reached its potential output, and firms cannot increase production without pushing up costs. As demand increases, firms face higher costs for labor and materials, which they pass on to consumers in the form of higher prices. This leads to inflation without any corresponding increase in real output.
In contrast, in the horizontal or upward sloping ranges of the AS curve, an increase in demand can lead to greater output and employment as firms are able to increase production to meet demand. However, in the vertical range, the capacity for increased output is limited.
This situation can contribute to demand-pull inflation, where too much demand for goods and services causes prices to rise, but without a corresponding increase in the quantity of goods and services produced. This is different from stagflation, which involves both rising prices and higher unemployment, and more unemployment or greater output would not occur in the vertical range.