Question 28

Lower price level and higher unemployment

A negative aggregate demand shock leads to a decrease in overall demand in the economy, which results in a lower price level and an increase in unemployment due to reduced production and consumption.

A) Higher price level and lower unemployment

This option is incorrect because a negative aggregate demand shock typically results in decreased demand, which would not lead to a higher price level. Furthermore, lower demand often leads to higher unemployment, not lower.

B) Higher price level and higher unemployment

While this option correctly identifies the potential for higher unemployment, it inaccurately states that a negative aggregate demand shock would cause a higher price level. In reality, the shock would decrease the price level as demand falls.

C) Lower price level and lower unemployment

This option is incorrect because, while it correctly states that a negative aggregate demand shock leads to a lower price level, it fails to recognize that such a shock typically causes higher unemployment due to reduced economic activity.

D) Lower price level and higher unemployment

This option accurately describes the effects of a negative aggregate demand shock. As demand decreases, prices tend to fall, and businesses often respond by laying off workers, resulting in higher unemployment.

Conclusion

The correct answer is D because it encapsulates the fundamental economic principle that a negative aggregate demand shock leads to both a decrease in the price level and an increase in unemployment. Options A, B, and C misinterpret the relationship between aggregate demand shocks and their impact on price levels and employment, failing to align with economic theory.