Long-Run Self-Adjustment Practice Test

Based on the AD–AS model shown, the economy is initially in a recessionary gap ($Y_1 < Y^*$). Assume there are no policy actions and that adjustment is not instantaneous. As unemployment remains above the natural rate, wages gradually fall. Which of the following describes what happens to the price level and real GDP as the economy moves from the short run to the long run?

Based on the AD–AS model shown, the economy begins in a recessionary gap ($Y_1 < Y^*$). Assume there are no policy actions. As the economy self-adjusts over time, which of the following changes is most consistent with wage and price flexibility restoring long-run equilibrium?