Under adaptive expectations theory, an increase in the short-run aggregate demand curve ____ the inflation rate and ____ the unemployment rate.
A) increases; increases
B) increases; decreases
C) increases; does not change
D) decreases; increases

Question

Quizplus · Accepted Answer

Under adaptive expectations theory, an increase in short-run aggregate demand leads to an increase in output and a temporary decrease in unemployment, but eventually, workers and firms adjust their expectations for inflation, causing wages and prices to increase. This results in a higher inflation rate in the long run and a return to the original unemployment rate. Therefore, an increase in short-run aggregate demand curve increases the inflation rate and decreases the unemployment rate in the short run, but increases the inflation rate and has no effect on the unemployment rate in the long run.

Under Adaptive Expectations Theory, an Increase in the Short-Run Aggregate