In the basic model with an AD and LRAS curve only, if spending growth is 7% and the Solow growth rate rises from 0% to 3%, then inflation will:

Question

Quizplus · Accepted Answer

A Solow growth rate of 3% indicates an increase in potential GDP growth, meaning the LRAS curve shifts to the right. This would lead to output growing at 10% (7% spending growth + 3% potential growth). However, with the increase in potential GDP, there is less pressure on prices because there is more supply to meet the demand. Therefore, inflation would decrease from 7% to 4%.

In the Basic Model with an AD and LRAS Curve