Suppose that the government implements expansionary fiscal policy that raises aggregate demand,but individuals incorrectly anticipate the policy measure (bias upward).According to new classical theory,in the short run the price level would ____________ and Real GDP would ______________.In the long run,new classical theory would predict that the price level would ______________ compared to its original long-run equilibrium level and that Real GDP would _____________.

Question

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In the short run, if individuals overestimate the impact of expansionary fiscal policy, they might demand higher wages due to expected inflation, leading to a rise in the price level and a potential decline in Real GDP due to decreased competitiveness or increased costs for businesses. In the long run, according to new classical theory, prices would adjust to reflect the true state of the economy, leading to a rise in the price level back to its original long-run equilibrium, while Real GDP would remain unchanged as the economy returns to its natural rate of output.

Suppose That the Government Implements Expansionary Fiscal Policy That Raises