Suppose that the economy is in long-run equilibrium and the government decided t

Question

Suppose that the economy is in long-run equilibrium and the government decided to engage in expected expansionary policy by increasing the money supply. If we assume rational expectations, which of the following statements is correct about the effect of expansionary policy in the long run?

A. The unemployment rate will remain unchanged, real GDP will remain unchanged and the price level will decrease.

B. The unemployment rate will increase, real GDP will increase and the price level will increase.

C. The unemployment rate will remain unchanged, real GDP will remain unchanged and the price level will increase.

D. The unemployment rate will decrease, real GDP will decrease and the price level will decrease.

Explanation / Answer

The right answer is C.

According to rational expectations, the firms will neither increase production nor hire more workers. The increased money supply will increase price level.

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