What happens to the economy when aggregate demand increases in the long run?

In the long run, when aggregate demand increases, the economy typically moves towards a new equilibrium characterized by higher output and price levels. However, the critical aspect to understand is that in the long run, the economy is generally expected to return to its potential output or full-employment level of GDP. This means that while an increase in aggregate demand can initially raise output above this level, adjustments will occur that lead the economy back to its long-run aggregate supply (LRAS).

As input prices and wages adjust to the increased demand, it results in upward pressures on prices, leading to a higher overall price level. Consequently, the economy stabilizes at this new price level, but the output ultimately aligns with its long-term capacity—full employment, and this does not mean prolonged unemployment or a shift in the short-run aggregate supply curve.

Therefore, the correct understanding is that after an increase in aggregate demand, despite initial shifts in output and price, the economy ultimately stabilizes at the full-employment level of GDP, making this option the most accurate representation of the long-run scenario in reaction to increased aggregate demand.