Suppose the economy is at full employment and firms become more optimistic about the future profitability of new investment.Which of the following will happen in the short run?

Question

Quizplus · Accepted Answer

When firms become more optimistic about future profitability, they are likely to increase investment. This increase in investment raises aggregate demand, which, in a full employment economy, tends to increase prices and reduce unemployment as firms hire more to meet the increased demand. However, since the economy is already at full employment, the main effect is on prices rather than unemployment decreasing significantly. The correct choice reflects an initial misunderstanding in explanation; the more accurate effect in this context is an increase in output and prices due to increased demand, not a direct decrease in unemployment.

Suppose the Economy Is at Full Employment and Firms Become