If people correctly anticipate an increase in government expenditures on goods and services so that their money wage rate adjusts immediately, then, assuming the economy is initially at potential GDP,
A) real GDP and the price level will increase in the short run, but the real wage rate will fall.
B) real GDP remains at potential GDP, there is no change in the price level, and the real wage rate rises in the short run.
C) real GDP remains at potential GDP.
D) real GDP, the price level, and the real wage rate all increase in the short run.

Question

Quizplus · Accepted Answer

If people correctly anticipate an increase in government expenditures on goods and services, their money wage rate will adjust immediately. However, as the economy is initially at potential GDP, there is no room for an increase in output beyond potential GDP. Therefore, the increase in government expenditures will not result in an increase in real GDP. Moreover, since the increase in government expenditures is not accompanied by an increase in supply, the price level will remain unchanged. Thus, real GDP remains at potential GDP without any change in the price level, which in turn means that there is no change in the real wage rate.

If People Correctly Anticipate an Increase in Government Expenditures on Goods