Question

Does price level always rise in a situation of increase in aggregate demand?

Answer 1

No, the price level does not always rise when aggregate demand increases. If the increase in aggregate demand (AD) is matched by a corresponding increase in aggregate supply (AS), the price level will not rise. However, once the economy reaches the full employment level, aggregate supply cannot increase further. Beyond this point, any further increase in AD will lead to a rise in the price level, i.e., inflation. Thus, the price level rises with increased AD only after full employment is reached; before that, output can increase without the price level rising.