According to the Phillips curve relationship, a contraction in potential GDP for whatever reason can be expected to
A) cause prices to climb as long-run equilibrium is reachieved.
B) cause prices to fall as long-run equilibrium is reachieved.
C) cause no effect on prices as employment adjusts in the long run.
D) cause no effect on real GDP because price adjustments would reachieve long-run equilibrium.
E) none of the above.

Question

Quizplus · Accepted Answer

A contraction in potential GDP implies a leftward shift of the long-run aggregate supply curve. As the economy adjusts to this new potential GDP, prices tend to rise in the process of reaching a new long-run equilibrium, according to the Phillips curve relationship, which describes an inverse relationship between unemployment and inflation in the short run.

According to the Phillips Curve Relationship, a Contraction in Potential