When the unemployment rate is below the natural unemployment rate,
A) real GDP is less than potential GDP.
B) real GDP is greater than potential GDP.
C) real GDP equals potential GDP.
D) None of the above is possible because it is impossible for the unemployment rate to be less than the natural rate.

Question

Quizplus · Accepted Answer

When the unemployment rate is below the natural unemployment rate, it indicates that the labor market is tight and employers are competing for workers. As a result, wages rise and production costs increase, which pushes up prices of goods and services. This situation leads to higher inflation and upward pressure on interest rates, which in turn can slow down the economy and lower real GDP. However, in the short run, the economy may experience an expansionary phase due to increased consumer spending and investment, resulting in real GDP being greater than potential GDP.

When the Unemployment Rate Is Below the Natural Unemployment Rate