From an initial long-run equilibrium with zero nominal demand growth,nominal GDP growth rises to a permanent 9 percent.If we assume adaptive expectations with a one-period lag,the dynamic process in response to the demand growth is
A)a loop that eventually terminates at Y = 100 with 9 percent inflation.
B)a loop that eventually terminates at Y = 100 with zero percent inflation.
C)a straight path to the northeast until we reach Y = 109 with 9 percent inflation.
D)in the first period Y = 109 with zero inflation,and every period thereafter Y =100 with 9 percent inflation.

Question

Quizplus · Accepted Answer

In the scenario described, the economy would adjust to the new nominal demand growth through a process of inflation. Given adaptive expectations with a one-period lag, individuals would adjust their inflation expectations based on the previous period's inflation. Starting from zero inflation, the initial response to a 9 percent increase in nominal GDP growth would lead to an increase in actual output as prices have not yet adjusted. Over time, as expectations adjust, inflation would rise to match the nominal GDP growth rate, leading to a new equilibrium where real output returns to its original level (assuming Y=100 is the long-run equilibrium output level), and inflation stabilizes at 9 percent. This process describes a loop where the economy experiences adjustments in output and inflation before settling at the new equilibrium with 9 percent inflation, aligning with choice A.

From an Initial Long-Run Equilibrium with Zero Nominal Demand Growth,nominal