The economy is in long-run equilibrium when government unexpectedly increases aggregate demand.The expected inflation rate is slow to adjust to the higher (actual)inflation rate.If follows that in the short run,according to the Friedman natural rate theory,__________ rises and the __________ falls.

Question

Quizplus · Accepted Answer

According to the Friedman natural rate theory, in the short run, if the actual inflation rate is higher than the expected inflation rate due to an unexpected increase in aggregate demand, Real GDP rises and the unemployment rate falls. This is because the unexpected increase in inflation temporarily lowers real wages, encouraging firms to hire more workers and produce more, leading to a decrease in unemployment and an increase in Real GDP.

The Economy Is in Long-Run Equilibrium When Government Unexpectedly Increases