Under adaptive expectations theory, a decrease in the short-run aggregate demand curve ____ the inflation rate and ____ the unemployment rate.
A) increases; increases
B) increases; decreases
C) decreases; increases
D) decreases; decreases

Question

Quizplus · Accepted Answer

Under adaptive expectations theory, a decrease in short-run aggregate demand leads to a decrease in output and an increase in unemployment in the short run. This increase in unemployment leads to a decrease in wages and prices in the long run, which shifts the short-run aggregate supply curve downward, causing a decrease in inflation. Therefore, a decrease in short-run aggregate demand decreases the inflation rate and increases the unemployment rate.

Under Adaptive Expectations Theory, a Decrease in the Short-Run Aggregate