Assume that expectations of P and A are correct. Now suppose that there is a 1.6% increase in A. Given this information, which of the following will occur?
A) A 1.6% increase in the real wage and an increase in the natural rate of unemployment.
B) No change in the real wage and an increase in the natural rate of unemployment.
C) A 1.6% increase in the real wage and no change in the natural rate of unemployment.
D) No change in the real wage and a decrease in the natural rate of unemployment.
E) A 1.6% increase in the real wage and a decrease in the natural rate of unemployment.

Question

Quizplus · Accepted Answer

According to the Solow-Swan model, an increase in A will lead to an increase in the real wage and a decrease in the natural rate of unemployment (as there are more productive workers available). Since the expectations of A are correct, there will be no additional effect on the natural rate of unemployment. Therefore, the only effect will be a 1.6% increase in the real wage.

Assume That Expectations of P and a Are Correct