If the economy is initially at potential GDP and people correctly anticipate an increase in inflation so that their money wage rate adjusts immediately, then
A) only real GDP increases with no change in the price level.
B) only the price level rises with no change in real GDP.
C) both the price level and real GDP increase.
D) neither the price level nor real GDP increase.

Question

Quizplus · Accepted Answer

When people anticipate inflation and adjust their wage demands accordingly, it leads to an increase in the cost of production for firms. This typically results in higher prices for goods and services, raising the overall price level. However, since the economy is already at potential GDP, there is no room for real GDP to grow further without causing overheating. Therefore, the price level rises, but real GDP remains unchanged.

If the Economy Is Initially at Potential GDP and People