If the economy is initially at potential GDP and people correctly anticipate an increase in inflation so that their money wage rate adjusts immediately, then
A) neither the price level nor real GDP increase.
B) both the price level and real GDP increase.
C) only the price level rises with no change in real GDP.
D) only real GDP increases with no change in the price level.

Question

Quizplus · Accepted Answer

If people's money wage rate adjusts immediately to an anticipated increase in inflation, then the cost of production increases. Firms will respond by increasing prices, leading to an increase in the price level. However, since the economy was already at potential GDP, there is no room for further production without causing inflationary pressures. Therefore, real GDP remains unchanged while the price level rises, making choice C the correct answer.

If the Economy Is Initially at Potential GDP and People