Starting from an initial long-run equilibrium, under the adaptive expectations hypothesis, a shift to a more expansionary policy will increase
A) prices and unemployment in the long run.
B) real output in the short run but not in the long run.
C) real output in the long run but not in the short run.
D) real output in both the long run and the short run.

Question

Quizplus · Accepted Answer

Under adaptive expectations, people adjust their expectations based on past experiences. An expansionary policy will initially increase real output in the short run as prices are sticky. However, in the long run, as expectations adjust and prices rise, real output returns to its natural level, leaving no long-term increase in real output.

Starting from an Initial Long-Run Equilibrium, Under the Adaptive Expectations