Suppose we assume that initially
,
,
;if
Rises 2 percent and the real interest rate falls 2 percent,short-run output:
A)falls 2 percent.
B)rises 1 percent.
C)rises 3 percent.
D)falls 1 percent.
E)does not change.

Question

Suppose we assume that initially 
, 
, 
;if 
Rises 2 percent and the real interest rate falls 2 percent,short-run output:
A)falls 2 percent. 
B)rises 1 percent. 
C)rises 3 percent. 
D)falls 1 percent. 
E)does not change.

Quizplus · Accepted Answer

An increase in the expected inflation rate (in this case, 2 percent) and a decrease in the real interest rate (also in this case, 2 percent) would lead to an increase in short-run output due to the stimulative effect on aggregate demand. Specifically, the increase in expected inflation would lead to an increase in consumption and investment spending, while the decrease in real interest rates would reduce borrowing costs and also stimulate spending. The combined effect would be an increase in short-run output by 3 percent. Therefore, choice C is the best answer.

Suppose We Assume That Initially