What is the outcome of an increase in aggregate demand if wages are not flexible?

An increase in aggregate demand with inflexible wages leads to a situation where the economy cannot achieve its full-employment level of GDP. In a typical scenario, if aggregate demand rises, businesses would respond by increasing production to meet the higher demand. However, if wages are rigid and do not adjust, firms cannot simply hire more workers or pay higher wages to attract necessary labor.

This lack of flexibility prevents the economy from reaching its potential output—where all resources, including labor, are utilized efficiently. Instead of facilitating growth towards full employment, the inelasticity of wages may lead to higher prices without a corresponding increase in output. As a result, the economy cannot expand to the full-employment GDP because businesses are constrained by the inability to adjust their labor costs. Therefore, the correct answer identifies this key limitation on the economy's performance due to rigid wages in the face of rising aggregate demand.