Question

in the dynamic model of AD-AS, the economy is in . long run equilibrium in year 1 and is expected to be in short-run equilibrium bellow potential GDP in year 2, and the federal reserve pursues the appropriate policy, because policy will work more quickly than the automatic adjustment mechanism this will result in.

A) real GDP lower than what would occur if no policy had been pursued.
B) unemployment rates higher than what would occur if no policy had been pursued.

C) inflation higher than what would occur if no policy had been pursued.
D) short-term interest rates higher than what would occur if no policy had been pursued.

Answer 1

C) inflation higher than what would occur if no policy had been pursued.

(Government would use expansionary fiscal policy to reach potential GDP which will increase AD and AD will shift upward to the right. Thus, both output and price level will increase and in the absence of policy, short run aggregate supply (SRAS) would increase because of unemployment in short run so labor becomes cheaper and production increases. Thus, SRAS will increase and shift rightward. So, output would increase and price level would decline. Thus, government policy would entail higher inflation than what would occur if no policy had been pursued.)